Background

The Court of Appeal in McCarthy v McCarthy and Stone PLC, has confirmed the High Court’s judgment that any discretion reserved for the employer in the exercise of options under the option plan rules must be interpreted very narrowly.

Facts

The Claimant was a director and an employee of the Defendant. After his retirement the Claimant sought to exercise his options over all shares which had been granted under the Defendant’s share option scheme. The Defendant’s Remuneration Committee (RC) allowed the Claimant to exercise his option over only 75% of his shares, concluding that the Claimant had allied himself with interests of a competing business and had not been in a position to make any material contribution to the performance of the company or the achievement of the ‘performance condition’ necessary to exercise the option.

The Claimant argued that the performance condition for exercise of the options was achieved despite these matters. The Claimant also argued that the performance condition was over 3 years and the alleged misconduct (which was not proven) was for 3 months; therefore if the reduction of 25% was designed to take into account the 3 month period, it was disproportionate. The Court held that the Claimant had achieved 100% of the performance condition. The Court held that the RC was required to go through a 2 stage process. First, the RC had to use their absolute discretion in deciding whether to allow the shares to be exercised, taking into account bona fide factors relevant to the Claimant’s conduct. Here, it could not possibly be bona fide to take into account the factors referred to by the RC as (i) they did not affect the satisfaction of the performance condition, and (ii) the Defendant had remedies for such conduct but had chosen not to institute any proceedings. Secondly, the RC had to decide whether the option holder could exercise all or a proportion of his options. If a proportion, this was to be determined pro rata to the achievement of the performance condition, the RC having no discretion as to the extent of the exercise.

Effect on employers

Following this decision, it is clear that any discretion that the employer has in relation to share options must be interpreted very narrowly and, even if it suspects that an employee is guilty of gross misconduct, exercise of the share options must still be governed by the share plan rules. One solution may be to draft the option rules broadly, leaving wide discretion for the employer. However, this creates its own problems as some companies may be unwilling to approve plans which leave significant discretion to the Remuneration Committee. Additionally, any wide discretion is likely to be fettered by the company’s own actions, as it unintentionally sets precedents which may later be found to be binding. Recent case law related to bonus payments indicates in any event that a requirement of reasonableness may be imposed on the exercise of discretion by an employer.