Remuneration of executive directors. Regarding the DGRN resolution dated October 31, 2018

Those of us who have the habit (I don’t know if healthy or unhealthy) of looking at the Official State Gazette at mid-morning on November 20, 2018, we had lunch with a new resolution from the Directorate General of Registries and Notaries (“DGRN“) dated October 31, 2018, this time concerning the remuneration of executive directors, which, after a few days, we are still digesting.
This resolution is a lesson about the history of law (and now you will understand why), which consists of 14 pages, all of them basically devoted to a broad review of how the interpretation of the articles relating to the remuneration of executive directors has evolved, with the exception of the first page in which the factual assumption is raised by means of the transcription of the article of the bylaws under consideration, whose negative qualification on the part of the competent mercantile registrar is object of the appeal of the one that brings the mentioned resolution, and of the last leaf in which in 2 paragraphs the outcome is solved, that ends in tragicomedy as lately they come accustoming us the different organisms that have entrusted the difficult, arduous and not less ungrateful task of interpreting the rule.
Since my only interest is to preserve your health, avoiding that the complete reading of the resolution produces heaviness and acidity in your stomachs (I am fully aware of what can be suffered with it), I am going to explain the state of the situation by milestones:

Milestone 1: Situation until Law 31/2014, of December 3

Until the reform introduced by Law 31/2014, of 3 December, to the Law on Capital Companies (“LSC“), the remuneration of directors had a single treatment, in the sense that there was no differentiation between the different ways of organising the administration (ie. sole director, joint or several directors and board of directors) or between the different functions that could be carried out by directors (ie. deliberative and/or executive functions), which were set out in articles 217 to 220 LSC.
After several comings and goings, the Civil Chamber of the Supreme Court adopted the so-called “teoría del vínculo” developed by the Social Chamber of the aforementioned Court, by virtue of which, in those cases in which the administrator, in addition to carrying out activities related to social management, performs senior management functions, the inclusion or exclusion from the scope of work cannot be established on the basis of the content of the activity, but must be based on the nature of the link and the position of the person who develops it in the organisation of the company, so that if the company belongs to the management body, the commercial relationship absorbs the employment relationship.
With regard to the remuneration of directors, the acceptance of the “teoría del vínculo” in the civil/mercantile seat meant that any remuneration received by a director of the company, be it by virtue of his status as director or by virtue of the performance of senior management functions, had to be contemplated in the bylaws, thus establishing what is to be called a principle of reserve law for the remuneration of directors. This was without prejudice to the fact that the director received remuneration for the provision of services or work, which was required in the case of limited liability companies (and was therefore sufficient without the need for a statutory provision, resolution of the general meeting).
Let us take an example to make it clearer: a manager who had the trust of his company and was “rewarded” with his appointment as a company director, by application of the “teoría del vínculo”, his relationship with the company ceased to be employment and became mercantile, and his remuneration must therefore be included in the bylaws, on pain of risking being left unpaid and without the possibility of demanding payment of his remuneration from the company.
In addition, the company’s administrator was an excellent architect and carried out architectural projects for the company for which he received remuneration. In this case, it was not necessary for this remuneration to appear in the bylaws, requiring only, in the case of limited liability companies, that there be a resolution of the general meeting authorising this relationship of provision of services (or work) between the administrator and the company.

Milestone 2: From Law 31/2014, of 3 December to the judgment 98/2018, of the Civil Chamber of the Supreme Court dated 26 February 2018.

The reform introduced by Law 31/2014 of December 3, 2014, to the LSC, led to the seat of remuneration of the administrators, for what is of interest here, as follows:

(i) Article 217 LSC is amended, qualifying that the remuneration system established in said article refers to directors “in their capacity as such”.
(ii) Concerning the Board of Directors, two new sections are added to article 249 LSC referring to the remuneration of directors with executive functions, establishing (a) the need for a contract to be signed between the former and the company, which must be previously approved by the Board of Directors with the favourable vote of two thirds of its members and be incorporated as an annex to the minutes of the meeting, abstaining from attending the deliberation and from participating in the vote of the director concerned; (b) the need for the contract to be in accordance with the remuneration policy approved, where applicable, by the general meeting and for it to detail all the items for which remuneration may be obtained for the performance of executive functions, including, where appropriate, any compensation for early termination of such functions and the amounts to be paid by the company for insurance premiums or contributions to savings systems; and (c) the prohibition on directors receiving any remuneration for the performance of executive functions whose amounts or items are not provided for in the aforementioned contract.
(iii) Concerning listed companies, inclusion of a new section, Section Three, in Chapter VII of Title XIV, relating to the specialties of directors’ remuneration, which expressly distinguishes between (a) the remuneration of directors for their status as such, which must be set forth in the bylaws and whose determination corresponds to the Board of Directors in view of the functions and responsibilities attributed to each director, membership of board committees and other objective circumstances that it considers relevant; (b) the remuneration of directors for the performance of executive duties, in respect of which the board of directors is attributed the power to establish the same and the terms and conditions of their contracts with the company in accordance with the provisions of article 249.3 and with the directors’ remuneration policy approved by the general meeting.

With regard to the remuneration of the directors of listed companies, this reform has meant that in the bylaws it is only necessary to contemplate the remuneration of directors for their status as such (ie. deliberative functions) and not the remuneration of directors for performing executive functions, which must be regulated in the contract referred to in article 249.3 LSC and respect the directors’ remuneration policy approved by the general meeting. While concerning non-listed companies, although the majority of the doctrine was inclined to consider that, as in the case of listed companies, inclusion in the Articles of Association is only necessary for the remuneration of directors as such, the issue has not been (see http://vecillacamazon.com/en/compensation-of-administrators-non-listed-companies-vs-listed-companies/) nor is it a peaceful one, and the latest resolutions -judicial and administrative- that have fallen on this matter only create more shadows than lights, as is made clear below.

Milestone 3: Sentence 98/2018, of the Civil Chamber of the Supreme Court dated 26 February 2018.

The merit of this ruling is the fact that for the first time (and only to date) the Supreme Court (“SC“) has had the opportunity to rule on the scope of the reform introduced into the CSL by the aforementioned Law 31/2014, of 3 December, regarding the remuneration of administrators, which has been the subject of numerous criticisms and leaves, in my opinion, dissatisfied both supporters and detractors of the principle of statutory reserve for the remuneration of directors who perform executive functions.
In essence, the SC ruling upholds the principle of the statutory reserve for all directors’ remuneration, without making any distinction between deliberative and executive functions, briefly shedding light on the existing controversy. A light that suddenly turns into complete darkness that only leads to the most absolute confusion, by pointing out that this principle of statutory reserve does not have the scope with which it has been interpreted until now, but must be interpreted in a less rigid, more flexible manner, without the SC clarifying the extent of this flexibility or at least the criteria to be taken into account, thereby creating a sort of “escape clause” (or, in other words, salvation table) which, as will be said later, is the one to which the DGRN refers in its resolution of 31 October 2018.

Let’s see what I mean by lights and shadows:

(i) Statutory reserve principle: The SC holds that in non-listed companies the relationship between the aforementioned articles 217 and 249 LSC is not one of alternativity in the sense that the remuneration of directors who do not exercise executive functions is governed by the provisions of article 217 LSC (ie. need for inclusion in the articles of association) and that of directors who perform executive functions is governed by the provisions of article 249 LSC (ie. contract approved by the board of directors without the need for inclusion in the articles of association). But such relationship is cumulative, therefore article 217 is applicable to all directors and, furthermore, in the case of directors with executive functions, the signing of a contract is required, the content of which must comply (a) with the “statutory framework”; (b) the maximum annual amount of the directors’ remuneration, in the performance of their duties, established by resolution of the general meeting, within the scope of which the board of directors exercises its competence to decide on the distribution of the remuneration corresponding to the directors; (c) the general criteria established in article 217.4 LSC (ie. reasonable proportionality to the importance of the company, the economic situation at any given time and the market standards of comparable companies and orientation towards promoting the long-term profitability and sustainability of the company and incorporating the necessary precautions to avoid excessive assumption of risks and the reward of unfavourable results); and (d) to the specific requirements established in articles 218 and 219 LSC when the remuneration items established in such legal precepts (ie. profit-sharing and delivery of shares) are established as remuneration items.
(ii) Flexible interpretation: For the SC, the attribution to the board of directors of the power to agree on the distribution of remuneration among the different directors and the power to approve a contract with the managing or executive directors on a mandatory basis, implies the recognition of an area of autonomy “within the statutory framework”, understood in a more flexible manner, should enable the remuneration of executive or managing directors to be adapted to the changing demands of the companies themselves and of economic traffic in general, combining this with due guarantees for shareholders, who should not be surprised by disproportionate remuneration not provided for in the articles of association and above the maximum annual amount that the shareholders’ meeting has agreed for all the directors of the company.

The flexibility criterion that, in the words of the SC, had already been accepted in rulings interpreting the LSC in its wording prior to the reform introduced by Law 31/2014, of 3 December, consisted of qualifying the statutory reserve as a reserve in terms of the need to establish a system or systems of remuneration, with the possibility of alternative, non-cumulative fixing, provided that the decision on the system to be applied and the procedure for determining the remuneration were not left to the discretion of the general meeting, the establishment of the competence of the general meeting to determine the amount annually being sufficient for this purpose.
The following questions therefore now arise:

Is it the intention of the SC to make even more flexible the interpretation given by the regulations prior to the reform introduced by Law 31/2014, of 3 December, to the principle of statutory reserve?

From his words, it is intuited that yes, but we do not know because he does not tell us (I do not know if intentionally or not, I leave it to his discretion) how far that flexibility goes.

How does the SC intend that the remuneration of executive or managing directors should be adapted to the changing demands of companies and economic traffic, if this has to be combined with the due guarantees to the partners (ie. statutory fixing and establishment by the general meeting of the maximum annual amount)?

It seems that, as it seems that this is the way in which the DGRN wants to go, it would suffice to expressly indicate in the Articles of Association that the position of executive director is remunerated, leaving to the Board of Directors the power to determine in the contract to be signed between the company and the director in question what this remuneration will consist of.

If the foregoing is true, it may be asked whether it would not have been enough for the flexibility proposed by the SC, without diminishing the guarantees for the shareholder, to have translated into the only requirement, which, incidentally, is already provided for by law, that the remuneration of the managing or executive directors must in all cases respect the remuneration policy approved by the general meeting and not exceed the maximum annual amount agreed upon by the shareholders.

With all these questions and many more that may occur to you, we come to the last milestone to date.

Milestone 4: Resolution of the General Directorate of Registries and Notaries dated 31 October 2018

The DGRN bases its decision to uphold the appeal filed and, therefore, to revoke the classification of the registration of the article of the articles of association which includes the remuneration of administrators, on the basis of the following arguments:

(i) The factual situation which is the subject of the SC ruling is not comparable to the factual situation which is the subject of the DGRN resolution, and this is because, unlike the DGRN, the latter does not categorically exclude any statutory reserve and the competence of the company’s general meeting with regard to the remuneration of executive directors, but provides that directors who perform executive functions shall be entitled to receive it, In addition (it is understood that the remuneration that would correspond to him for his condition as a director as such), the remuneration that corresponds to the performance of the same and literally reproduces sections 3 and 4 of article 249 of the LSC.
(ii) The registrar starts from a mistaken premise, which is that the paragraphs whose registration is denied do not establish the system or system of remuneration of the managing directors, which in the opinion of the DGRN is uncertain, since the joint reading of both paragraphs, in addition to the attendance and death allowances (remuneration that would correspond to the director for his condition as such), could also lead to the compensation for early termination and the amounts to be paid by the company for insurance premiums or contributions to savings systems.

The DGRN, beyond the interest aroused by its resolution as it is the first resolution that falls after the SC’s ruling of 26 February 2018, contributes to generating even more uncertainty.

This uncertainty is generated not only by what it says:

(i) To warn, as we already knew, that we are dealing with a single SC ruling, in order to imply that the same ruling does not cause jurisprudence and, therefore, that the DGRN is not obliged to follow its criteria, which we imagined.
(ii) Just to make a comparison of the factual assumptions in order to conclude that we are dealing with different factual assumptions.

But also because of what it does not say:

(i) It does not expressly pronounce on the enforceability or not of the principle of statutory reserve in the matter of remuneration of directors who exercise executive functions, although it is intuited from its argumentation that the DGRN accepts the statutory reserve.
(ii) It is not clear where the DGRN understands that the flexibility of which the SC speaks finds its limits. Its resolution admits a statutory wording in which a totally open list of remuneration items is presented, considering as such a series of items that are preceded by the expression “including where appropriate”, although it does not clarify the specific manner in which the different remuneration systems must be established, whether if there are several, they must be established cumulatively or it is sufficient for them to be done in an alternative manner, nor, in short, does it establish criteria that allow a general criterion to be established on the scope of the flexibilisation referred to by the SC in its ruling of 26 February 2018.

And because of the main question before us:

If the principle is really going to be consolidated in the Articles of Association, since such an open list of remuneration systems is accepted, is it more than enough for the Articles of Association to limit themselves to stating that the position of executive director is remunerated, leaving said remuneration to be specified in the contract to be signed between the company and the director in question?

Given the wording of the bylaws, the registration of which is being admitted, at least as regards the position of the DGRN, it would appear that it is.

Conclusion

Far from having established a regulatory framework that provides legal certainty, we find ourselves in a situation of uncertainty regarding the remuneration of administrators that generates insecurity not only for the citizen but also for the legal operators that we are in charge of applying the Law and that we find ourselves immersed in a roulette game where each time we have to put a card we are not sure which number to bet on, which ultimately results in prejudice to the addressee of the rule, our clients. All of this is the result, on the one hand, of a not entirely refined legislative technique seasoned by an incomplete interpretation of the rule by the courts and administrative bodies that generates the emergence of concepts that condition the interpretation of the rule and whose definition is not entirely clear.

What is desirable in this case, as in any other, is for a clear regulatory framework to be established once and for all that does not give rise to ambiguous interpretations by the bodies in charge of such a task that ultimately affect the taxpayers’ pockets, to the extent that we are faced with a situation in which the implications do not remain in the sphere of society but transcend the public purse due to the fiscal implications that the principle of statutory reserve is being given (ie. consideration of non-deductible expenditure, mere liberality, etc.).
Finally, a recommendation, if I may, to you who are ultimately the main affected party, is that it is time not to carry out experiments, to be cautious and that until the situation is clarified, if you are going to opt (or have already opted) for the formula of the Board of Directors, in the event that those directors who exercise executive functions are going to be remunerated, establish in your Articles of Association the remuneration of such directors as clearly and precisely as possible under the advice of a good professional.

 

November 2018
2018 José Luis Vecilla Camazón. All rights reserved

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