This article outlines some of the key considerations that should be taken into account when a company proposes to dismiss senior managerial staff and illustrates how those considerations can be used to inform matters that should be dealt with when a senior employee joins.

The case study

SME Pty Ltd is a small private company that manufactures motor vehicle parts in Victoria. It was founded by John and Jack.

Jane is employed by the company as its CEO. She was initially appointed under a one page appointment letter in early 2003 when business was good. Her position is ongoing and she is paid an annual salary of $300,000.

John and Jack have focussed on other business interests and retain limited involvement in the business day to day. John, Jack and Jane each own a 33.3% interest in the company.

In light of the economic downturn, John and Jack have decided to initiate a change in strategic direction. They are also unhappy with aspects of Jane's management and have decided that the time has come for them to part ways.

Jane believes the business can be turned around if she is given a chance and has made it clear that she won't agree to go without a fight.  

Key considerations

Senior employees in management positions will typically not be protected by awards or collective agreements or have access to statutory remedies such as unfair dismissal. Nonetheless, there are a number of legal issues of which employers wishing to dismiss senior staff need to be mindful.

Termination with notice

As Jane's appointment letter does not set out the period of notice required to terminate her employment, the company will be required to give her "reasonable notice". Given Jane's seniority and length of service with the company, and the difficulty she is likely encounter securing equivalent replacement employment in the current climate, her reasonable notice entitlement could be anywhere between six and 12 months. If the company moved to terminate her without honouring that entitlement, Jane would have a good claim for compensation (up to say $300,000) against the company.

In an ideal world, the company would have had Jane sign an employment contract containing customary clauses dealing with termination and giving the company the right to determine whether or not the notice period is worked out. A well drafted contract would have saved the company from its current predicament.

General law duties

In addition to the reasonable notice requirement, other general law doctrines may affect the termination of an employment contract.

For instance, the doctrine of 'mutual trust and confidence' may impose a duty on the company not to conduct itself in a manner likely to destroy or seriously damage the relationship of confidence and trust between employee and employer.

While the doctrine has not yet been fully endorsed by an Australian appellate court, there are signs that courts may be becoming increasingly willing to imply a duty of mutual trust and confidence in employment contracts.

Recent case law suggests that breach of the implied duty of mutual trust and confidence may enable Jane to seek further damages for distress and disappointment.

Restraint of trade

Jane's appointment letter does not contain a clause preventing her from competing with the company or soliciting its employees after her employment ends. This will mean that the company will have real trouble preventing her from working for a competitor and poaching the company's staff after she leaves.

Courts keenly protect the freedom of individuals to practise their trade and the law will presume that a contractual clause which purports to restrict an employee's right to compete following termination of employment is unenforceable. However, an employer who can prove that a post-employment restraint is reasonable and necessary to protect its legitimate business interests may be able to rebut the presumption.

Well drafted restraint clauses can provide important protection particularly where a senior employee has had access to information and developed commercial relationships capable of causing serious damage to the business.

Transfer of Jane's shares

Another problem facing Jack and John is that Jane has built up a significant shareholding.

While together they retain control of the company, John and Jack have no contractual ability to force Jane to sell her shares if they decide to terminate her employment. As a consequence, she is likely to use her shares as leverage against them in any settlement negotiations.

This problem could have been avoided had a special employee class of shares been created and issued to Jane requiring her to return her shares on exit or alternatively if a shareholders' agreement giving John and Jack a right to buy her shares on the basis of a pre-determined valuation been put in place.

Conclusion

Employers who ensure arrangements with senior employees are well documented will be best placed to manage any issues which arise if the relationship deteriorates to a point where dismissal is the only option.