Following consultation in relation to the Exposure Draft of the Federal Government’s proposed legislation limiting termination payments to certain executives, the Corporations Amendment (Improving Accountability on Termination Payments) Bill 2009 (Bill) was introduced into Parliament on 24 June 2009.

At this stage, the Regulations to accompany the Bill have not been finalised. The government has indicated that the Regulations will be subject to ‘targeted consultation’, but will be finalised in time for commencement of the new legislation.

The intended commencement date of the new regime also remains unclear. The winter session of Parliament finished on 25 June 2009, so it is likely the legislation will not be passed until the spring session of Parliament (which commences on 11 August 2009) and will not subsequently commence until Royal Assent is obtained—probably November or December.

In this article we discuss the differences between the Bill and the Exposure Draft and suggest some practical issues which may arise from the application of this legislation when it comes into effect.

Summary

The key components of the legislative changes remain the same in the Bill as the Exposure Draft, namely:

  • termination payments are to be capped at one year’s average base pay unless shareholder approval is obtained
  • the shareholder approval requirement is extended to cover termination payments made to senior executives and key management personnel of disclosing entities (and anyone who has held such a role in the three years before termination) rather than just directors (and some former directors). However, for non-disclosing entities the requirement will only apply in respect of directors (and anyone who has held such a role in the three years before termination)
  • the definition of ‘termination benefit’ will be expanded and clarified to catch any payment, other consideration, property or right and, subject to the regulations, include the accelerated or automatic vesting of options and payments in lieu of notice but not ‘deferred bonuses’
  • unauthorised termination benefits are to be repaid immediately with any unpaid benefits to be held on trust by the executive for the company, and
  • penalties for breach of the shareholder approval requirement will be increased.

However, the Bill differs from the Exposure Draft in two significant respects:

  • Contracts attracting new provisions – the Bill makes it clear that the new provisions will apply not only to contracts entered into or extended after the changes take effect, but also to any contract that is materially varied after the commencement of the new provisions. The Explanatory Memorandum specifically notes that any change to an existing contract term relating to remuneration will be treated as a material variation.
  • Shareholder approval process – the limitation on the timing of shareholder approval under the Exposure Draft (effectively preventing a company from obtaining shareholder approval for a termination benefit until the next AGM after the director or officer ceases employment) has been abandoned. The government has responded to feedback that this limitation would make it unfeasible in practice for companies to obtain shareholder approval, and the Bill essentially preserves the current position (subject to some minor procedural changes) which allows a company to obtain shareholder approval at any time prior to payment of the termination benefit.

Pending the release of the draft Regulations, the exact scope of the proposed new regime remains uncertain in several important respects, including:

  • the definition of ‘base salary’ that will be used in calculating the 12-month limit (the government has seemingly abandoned the vague definition under the Exposure Draft but has not yet settled on a replacement), and
  • the specific benefits that will be included in and excluded from the new cap (including the definition of deferred bonus, and the extent to which superannuation contributions are carved out). The language used in the Explanatory Memorandum suggests that the government is still weighing up the submissions it received in response to the Exposure Draft on the classes of benefits that should be included in and excluded from the cap.

Which contracts will be affected by this legislation?

An issue in the forefront of many employers minds is: Which contracts will this legislation apply to?

While the Exposure Draft provided that the legislation would not be retrospective in its application to contracts settled prior to the commencement of the legislation, the Bill provides that the new provisions will apply not only to contracts entered into or extended after the changes take effect, but also to any contract that is materially varied after the commencement of the new provisions.

Further, the Explanatory Memorandum to the Bill specifically states that any change to an existing contractual term relating to remuneration will be treated as a material variation.

That is to say, if the remuneration of senior executives and key management personnel of disclosing entities and employees who have been directors of non-disclosing entities in the three years prior to the termination of their employment is varied, the new provisions will apply.

This will undoubtedly effect the negotiations employers will have with senior executives and key management personnel in relation to salary reviews in the future.

Employers should be wary when reviewing the salaries of senior executives and key management personnel and it may be prudent to make it a condition of any salary review that provisions are included in these employees’ contracts of employment which limit termination payments to an amount not requiring approval.

Shareholder approval process

The Bill abandons the limitation expressed under the Exposure Draft that the vote to approve termination benefits must be held after the officer’s employment has been terminated rather than at any point before the benefit is provided thereby returning the legislative position to how it is currently drafted.

Consequently, in accordance with the Bill, a company can obtain shareholder approval at any time prior to the payment of the termination payment.

This is an important change given the possible consequence that officers may have delayed their departure until shortly before the notice of the next annual general meeting is sent as it may have been less likely that a termination benefit would be approved if a large amount of time had elapsed since the officer’s departure.

Further, this amendment avoids the possibility that new employers would have been pressured into providing compensation to officers where they had departed from their previous employment at a time which was not close to a general meeting.

Importance of the draft regulations

An understanding of the true scope of the Bill will only be possible once the government releases its draft regulations.

This is because the regulations will clarify the definition of the terms ‘base salary’ and ‘termination benefit’.

Under the draft regulations released in accordance with the Exposure Draft, the term ‘base salary’ was defined as having the meaning generally accepted by the accounting profession. This vague definition has been abandoned and has been left to be defined in the draft regulations.

More importantly the regulations will clarify what will be included and excluded as a ‘termination benefit’.

The draft regulations released in accordance with the Exposure Draft provide that the following are termination benefits:

  • the automatic or accelerated vesting of options, and
  • a payment in lieu of the giving of notice of termination.

They also state that the following are not termination benefits:

  • deferred bonuses, and
  • payments from a defined benefit superannuation scheme that is in existence when the regulation commences.

If these draft regulations are implemented, then the term ‘termination benefit’ will be expanded to include payments in lieu of notice and will therefore override the current common law which provides that payments in lieu of notice are not ‘termination benefits’ under the Corporations Act 2001 (Cth) but, rather, payments required to bring about the effective termination of the employment relationship.

Such an amendment would have a significant effect on the termination of employment of senior executives who are often afforded up to 12 months’ notice in order to allow businesses adequate opportunity to undertake succession planning and perform recruitment searches with due diligence, but in respect of which a payment in lieu of part or all of the period is often made. This amendment would likely have a two-fold effect:

  • companies would more frequently require shareholder approval of termination benefits to executives, and
  • executives may more likely remain employed during the period of notice of termination, whether working or not working/’gardening’ so that the payment during this notice period is not included in the cap.

The carve-out of ‘deferred bonuses’ from the definition of ‘termination benefits’ may also affect the structure of executives’ remuneration. While the Explanatory Memorandum for the Exposure Draft sets out that ‘deferred bonuses’ are bonuses which have been earned but not yet paid, we await clarification of this definition.

Update on taxation treatment of grants under employee share schemes

Relevant to this discussion is an update on the likely commencement date of the government’s proposed amendments to the legislation governing the taxation treatment of employee share schemes.

The Senate has now referred the matter of the operation of employee share schemes in Australia to the Standing Committee on Economics for inquiry and report by 17 August 2009.

The effect of this is that it is unlikely that the proposed amendments will be passed until late August at the earliest.

There is however still uncertainty as to whether the proposed amendments will be effective from 1 July 2009 (as set out in the government’s consultation paper on the ‘reform of the taxation of employee share schemes’) or whether the commencement date will be further delayed.

This will likely deter companies from making equity grants to employees in the period between 1 July 2009 and the date on which the proposed amendments are enacted.