A ruling by the Spanish Supreme Court changes the views as to the remuneration of Executive Directors

A recent ruling of 26 February 2018 by the Supreme Court (hereinafter, the "Ruling") has turned around the status quo on the remuneration of executive directors. 

Following the reform of the Capital Companies Act (hereinafter, the " CCA ") in 2014, it was generally understood by a meaningful segment of scholars and practising lawyers, and sustained by the administrative doctrine of the General Directorate of Registries and Notaries, that the law set out two different means of determining a director's remuneration: One for directors "as such" which would be set forth in the company bylaws and by agreement of the general shareholders' meeting in accordance with section 217.3 CCA; and another system for the executive directors, which would fall outside the general system of art. 217 CCA and which would be governed by sections 2 and 3 of art. 249 CCA. This implied two important things: 

• That it was possible that even if the bylaws provided that the position as director "as such" (as stated by art. 217.2 CCA) was not remunerated, specific directors to whom executive powers had been delegated would be able to receive a remuneration for these executive functions, by virtue of section 249 CCA. Such remuneration was set out in an agreement and was resolved on by the board of directors leaving the general shareholders' meeting aside. 

• That, as a consequence of the above, there were two different types of relationships which linked the director with the company: a "basic" one as director "as such", and an additional one, which could exist or not, as executive which would be reflected in an agreement and imply a separate remuneration. The CCA even foresees the possibility of setting an indemnity or compensation payable if executive functions were taken away. This was particularly relevant because, before the reform took place, the case law defended the existence of a single relationship between director and company, one of a corporate nature, which subsumed any other link which the director may have with the company. An employment relationship was not possible because any employment duties which may be entrusted to the director were believed to be included in the tasks pertaining to their position as director. Therefore no compensation for termination was possible as it is a general principle of corporate law that shareholders must be free to cease directors at any time and it was thought that a termination compensation payment could curtail this freedom.

To summarize: after the 2014 reform the understanding was: that there were two possible bonds and therefore that  a compensation for termination of an executive contract was acceptable, and that it was possible that the Board of Directors chose to pay the executive directors regardless of whatever it said in the  by-laws. All this is overturned by the Ruling.

In essence, the Supreme Court defends that the need for any remuneration to be reflected in the the bylaws is mandatory for both the remuneration of the directors "as such" and also for the additional "executive" functions with which they may be entrusted. Therefore:

• The performance of executive duties may only be remunerated if it is expressly is foreseen by the bylaws that the position as director is to be remunerated. This may imply a tax contingency for those companies that have paid remunerations to their executive directors, pursuant to an agreement signed further to section 249 CCA, while the company's bylaws stated that the position of director was not to be remunerated. The tax deductibility of such remunerations is subject to strict compliance with commercial law and therefore it is possible that the Tax Inspection, as it has done on other occasions when the legislation prior to 2014 was in force, contests the tax deductibility of the remunerations paid and that they are re-characterised as gratuities.
• All amounts to be paid under any concept under the agreement which the company may have signed with the executive director in accordance to section 249 of the CCA must now also be included in the bylaws and will be subject to the approval of the general shareholders' meeting which shall decide the annual maximum amount payable to all the directors as well as, where applicable, any additional particulars which the specific remuneration systems set out in sections 218 and 219 CCA may require. Within this framework the board of directors is allowed a certain discretion to distribute the amount authorised by the board, taking into consideration in so doing the duties performed by and functions attributed to the directors. 
• Since the existence of a dual relationship or link between company and director may no longer be defended, there may well be a return to the application of the so called "single link" and, accordingly, also the "unlawfulness" of termination compensations. The agreement referred to in section 249.3 CCA is deemed by the Supreme Court as being no more than a further explanation or extension of the contents of the board resolution whereby executive powers were delegated to the director. The agreement just serves the purpose of having the executive express his consent to bind himself to the company and accept such executive duties, but it does not constitute a separate relationship in addition to his initial appointment as director. The Supreme Court does not seem to recognise the existence of two separate overlaying relationships, on the contrary, it clearly states that "if any members of the board of directors perform any executive duties, they do it because  of their condition as directors, as only in such capacity they may receive the board's delegation".

Although a single ruling does not constitute case law, we recommend all company bylaws be amended to take into account the provisions of the Ruling as well as a revision of all contracts with executive directors signed since the end of 2014 pursuant to art. 249.3 CCA.