The risk of an undefined salary for a board member in Latvia

Under the respective provision of the Commercial Law (Article 221) in Latvia, it is stated and confirmed by the Senate (see case No. C33594518, SKC-71/2022) that a board member has the right to remuneration corresponding to their duties and the financial condition of the company.

The issue of the board members’ liability is a separate topic and shall be addressed in a separate article. Discussed herein are a few examples that can potentially lead to disputes between a board member and other participants or shareholders, or vice versa. In these rapidly changing economic circumstances, this risk can materialise in instances of board changes. Uncertainty regarding the board’s remuneration is a risk that affects not only relationships with third parties but also relationships with the tax authorities.

The International Accounting Standard (IAS 24), specifically requires the disclosure of this matter in financial statements, covering not only remuneration, but also other income and benefits obtained from the company, including compensation upon leaving the position of a board member and options. Auditors should pay more attention to these issues in order to ensure it is clear from the financial statements whether this matter has been properly addressed or not.

In general, there are several questions that can also affect or even provide grounds for a board members' claims against the company where there is a concluded agreement:

  • Whether the remuneration is fair?
  • Whether the remuneration is determined for all of the duties the board member had to perform?
  • Whether the financial condition of the company was directly related to the actions of the board member?
  • Whether the personal risk of the board member is taken into account if the company's operations or the actions of shareholders/directors are unlawful or otherwise immoral?
  • What happens with unused vacation days if an employment contract with a board member is concluded (there are also situations that are a legal absurdity involving state/local government administration)?
  • What are the financial capabilities of the company (e.g., significant equity or profit, reduction of losses, or consolidated results of the group), and can it be objectively determined by an expert?

Situation 1: Board member without a contract with the company

A classic situation for active companies or funds is when forming new holdings with multiple subsidiary companies, which are registered very often. Almost always, separate contracts with appointed board members are not concluded. Consequently, these board members may have rights to claim fair remuneration from the moment of their appointment to this new company.

To address this risk, in M&A transactions, it is stipulated in the relevant transaction documents that the board member waives any claims against the company if the board member resigns (or is removed from office). If the board member continues to work after the sale of shares, it is recommended to mitigate the risk by removing the board member from office (so the board member's remuneration risk remains with the seller) and appointing the same or another board member under the buyer’s defined terms for board member remuneration.

Situation 2: Board member pays themselves remuneration

As can be seen from the aforementioned Senate ruling, regular payment of remuneration is one of the criteria for assessing the compliance of a board member’s remuneration within the applicable legal provisions. It turns out, the absence of a shareholders’ resolution has not been a barrier to recognising this remuneration as lawfully paid if the shareholders’ intent can be determined in other ways. At the same time, it should be noted, regular payment of remuneration is not a guarantee that the board member will not demand additional remuneration which would be fair and justified based on the level of risk and responsibilities. In short, regular payments without a contract do not guarantee the absence of claims from the board member.

Situation 3: The company does not pay remuneration to the board member

This is the worst-case scenario as the board member is likely to demand remuneration at any time and in an unpredictable amount. The possible interpretation of the remuneration criteria in the Commercial Law (Section 221) is very broad, and they can be specified in each case, which can create an unnecessary risk for minority shareholders. If the majority shareholders have a good relationship with the board member, it does not mean the minority shareholders should not consider it as a potential risk.

The minority shareholders should not be modest in demanding restrictions on board remuneration in the statutes or shareholders agreements. Typical examples include:

  • 10% of annual net profit growth;
  • Termination compensation amounting to 30% of the previous year’s remuneration; and
  • Fixed annual remuneration and a percentage of EBITDA growth compared to the previous financial reporting period according to audited annual reports.

Although the Senate (see Case No. C30474417, SKC-48/2022) has ruled in another case that the assumption of office itself does not create a de facto entitlement to remuneration: “[...] the Senate acknowledges the appellant's argument that the appellate court did not establish that the claimant had actually and properly performed the work, and without such determination, the court could not conclude that the claimant had a right to remuneration.” However, this approach by the Senate is subject to critical evaluation on the understanding there is no provision in the Commercial Law permitting for the interpretation that board members must perform their duties without remuneration unless they have expressly waived such rights.

Situation 4: A board member has a contract with only one company

There are often situations where a board member has a contract with a company, which is properly executed in terms of form and content. However, after some time, the same individual holds multiple positions in new companies that are related to the initial company. The situation remains unchanged, and the board member has independent rights to claim compensation from each of these companies. Therefore, when entering into a contract (or in the context of the need to amend the contract) with a board member, consideration should also be given to these other new companies and the arrangement of contracts with them.

Conclusions:

The solution to all situations is simple - conduct a review of all positions held and duties performed by board members and enter into or amend and update contracts with them, obtaining the necessary approval of the shareholders’ meeting or board.

At the same time, the question arises regarding the period (especially if it spans multiple years) prior to the conclusion of a contract, where the best solution is always negotiations and agreements between the parties.

If dialogue does not progress, no one can prevent a board member from leaving their position by informing the Commercial Register of the Republic of Latvia (and, if possible, also the company and its shareholders).

In any event, a company can remove a board member from their position at any time and appoint someone else, based on a properly prepared board member contract.

by Gints Vilgerts, Managing Partner, Latvia

Team

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