The 2014 AGM season saw the first remuneration policy approvals under the Directors' Remuneration Report ("DRR") regime which came into force in September 2013. Although some companies have since been back to shareholders with revised policies, most companies have retained their policy unamended for the last three years. Those companies will, therefore, need to seek reapproval of their policy at their 2017 AGM.
Now is the time for those companies, and any others revisiting their policy, to think carefully about the content of their new policy and to take account of the lessons learned over the past few years. In particular, whilst policies should continue to focus on conveying a good message, and being reader friendly, they are still an important legal document. The policy overrides the rules of a share plan or the terms of a directors' service contract in the event of any inconsistency, and so should be reviewed with the same level of rigour as would be put into drafting a share plan or a service contract. We have seen many companies being surprised by problems caused by policies which were inadequately or loosely drafted and we strongly recommend that the opportunity is taken as part of the three year review process to ensure that policies are clearly drafted and consistent with underlying documents and, consequently, that the expectations of all stakeholders (whether shareholders, the Remuneration Committee or the executives themselves) are managed.
1. WHAT ARE THE KEY LESSONS LEARNED?
In our experience, one of the most common reasons for unexpected problems arising is the use of "summary" language (e.g. summaries of performance targets, or the terms of bonus plans, LTIPs and service contracts which do not reflect – and in some cases directly conflict with - the precise terms of the underlying documents). Often, this is a result of different people authoring different parts of the remuneration policy which leads to inconsistency within the policy. All contracts, share plans and other agreements which include remuneration provisions need to be subject to a very careful review and then accurately summarised, and an overall legal review is then recommended.
2. SERVICE CONTRACTS AND PILON
Particular issues have arisen from inadequate, ambiguous or incomplete descriptions of termination arrangements in service contracts in the termination of employment section of the policy. This is a critical area of the policy, where problems have all too frequently arisen from short-hand drafting and/or language giving too brief a summary of both the underlying contractual provisions and what a company should otherwise be authorised to pay.
For example, we have been asked questions regarding whether, as part of a payment in lieu of notice ("PILON"), salary and benefits may also cover bonus; whether a payment in lieu of accrued holiday can be made; and whether (reasonably valued) leaving gifts can be provided. It is also worth making sure that the policy covers the "little things" such as mobile phones, tablets and computers if an executive requests to retain these (unless the executive will pay market value for them in which case there is no element of "taxable benefit"). Alternatively, these could be covered as "ancillary benefits" e.g. a company could be allowed by the policy to provide benefits with a value of up to a certain percentage of annual salary. It is also worth making clear whether the company's enhanced redundancy policy (if any) can apply to the executive directors.
In relation to PILON, companies need to make sure that, as well as the policy being clear on what elements of remuneration can be included in a PILON payment, the policy is clear on the provisions that are in place in relation to staged payments and/or mitigation. If different directors have different contractual arrangements, then the policy needs to cover all arrangements accurately.
3. BONUS ON TERMINATION
We have encountered a range of issues in relation to bonus eligibility on the termination of an executive director, including:
- bonus descriptions not reflecting underlying service contracts and/or bonus terms (with older contracts often expressly providing for a payment in respect of bonus on termination and the position being less clear under the policy);
- the policy failing to take into account that an executive director may be eligible for two potential bonuses, where a notice period spans two performance years;
- the policy not being clear regarding what happens where a director is in employment but under notice of termination at the bonus payment date (and whether being on garden leave affects the outcome); and, separately, if there remains eligibility where director has left employment by the payment date;
- the bonus plan description being drafted separately from the section on share incentives and adopting different drafting styles which can cause confusion when interpreting the intention of the policy. For example, if both plans include specified good leaver provisions, one should not refer generically to "good leavers" or specific terms which do not correspond with the good leaver provisions in the share plans;
- stating in the policy section that a percentage of bonus is deferred into shares, but not including a discretion to waive deferral for bonuses paid after employment has ceased or where the director is under notice of termination (if that is indeed the desired outcome).
Where pre-27 June 2012 contracts have specific payment obligations, these obligations could be "grandfathered" without needing to be specifically referred to in the remuneration policy (i.e. the company can continue to pay out pursuant to their terms, even if they would not replicate those terms as a matter of policy in new service contracts). The intention behind grandfathering was to allow companies to honour an executive's pre-existing contractual rights. These are preserved so long as there has been no amendment to the contract since June 2012. Where termination provisions in a service contract are grandfathered, those provisions still have to be disclosed in the remuneration policy section on payments for loss of office.
Problems have arisen where service contracts which contain "grandfathered" provisions are amended, and particularly where companies have not realised that an increase in salary can count as an amendment. The effect? The grandfathered terms of the service contract have no effect, so the executive cannot rely on those more favourable provisions if they do not also form part of the policy - and paying out under them risks challenge by shareholders. Furthermore, executives may well not appreciate that a salary increase may prejudice rights to other payments under their service agreements, so companies have found themselves in an uncomfortable struggle between their duties to key executives and the restrictions imposed through the DRR legislation.
These problems can be avoided by effective communication with board executives on pre-June 2012 service contracts, explaining the impact of contractual amendments on grandfathered terms. Alternatively, it may be the case that shareholders have approved (or will now be prepared to approve) the grandfathered terms being a statement of policy at least in respect of current executives (although we accept that there may be challenges in bringing shareholders on board with that approach if they have previously been unaware of the arrangements).
5. OTHER ISSUES
Other issues that we have encountered which need to be thought about and carefully described include:
- accurately summarising the company's approach to compensation for statutory/other employment claims including on termination of employment;
- stating expressly whether, and if so to what extent, reasonable legal fees incurred by a director can be paid, for example in connection with a settlement agreement or on the effect of a transaction on the director's service contract (including where an executive director is advised by the Company to seek independent advice where a termination of employment is not inevitable);
- making it clear whether, in the change of control scenarios (e.g. under the LTIP), a description which seems narrower than the rules is intended to be a binding policy (rather than merely a summary of the LTIP provisions);
- ensuring the policy contains sufficient flexibility, including for example to make one-off awards to executives considered appropriate by the remuneration committee (although care needs to be taken in describing the circumstances in which such a power could be used). One approach may be to incorporate the power to make such an award in the shareholder-approved LTIP and include a reference to that power in the relevant description in the policy.
Finally, it is worth noting that if any issues arise in the context of a termination of employment which could lead to litigation, when taking professional advice (particularly if interpreting/applying a policy in difficult or potentially contentious areas), Remuneration Committees should consider whether the advice would need to be subject to legal professional privilege. In this regard, any advice from a remuneration consultant or accountant will not be subject to legal professional privilege and would need to be disclosed in proceedings.