A recent High Court case provides useful clarity that companies operating employee incentive plans should be able to link the exercise of a discretion to treat a departing participant as a "good leaver" to a condition that the participant has not breached their employment contract, or even that the participant complies with post-termination restrictive covenants.
This briefing discusses the recent case of Fahim Imam-Sadeque v BlueBay Asset Management (Services) Ltd, and then explores how this case is useful to companies wanting to link the exercise of a discretion under a share or bonus plan in favour of a leaver to a requirement that the participant complies with the terms of their employment or compromise agreement, or even with the participant's post-termination restrictive covenants.
In the Imam-Sadeque case, a senior employee who participated in a deferred bonus plan was to leave BlueBay. The parties entered into a compromise agreement, under which the participant went on a period of garden leave, at the end of which his employment would terminate. Under the compromise agreement, BlueBay agreed that the participant would be treated as a good leaver for his deferred bonus award, worth £1.7 million, on the condition that he complied with his compromise agreement. The compromise agreement included a general warranty given by the participant that he was not in breach of his employment contract, as well as a specific non-poaching covenant.
It subsequently came to light that the participant breached the terms of his employment contract and the compromise agreement, by having been in discussions to become a founding partner in a new fund management firm that was to compete with BlueBay, and by trying to poach another BlueBay staff member (over what proved to be the very expensive lunch!). Having discovered this, BlueBay decided not to allow the deferred bonus award to vest, and instead treated the award as lapsing in full.
The participant brought a claim for the deferred award on two grounds. Firstly, he argued it was incorrect that his actions were a breach of contract, such that the award would be forfeit, but this claim failed comprehensively.
The second argument was that if he was in breach, the condition in the compromise agreement which resulted in his deferred bonus award lapsing in consequence of his breach was an unlawful penalty, because the object of the clause was not to legitimately compensate BlueBay for the loss it incurred. The Court also rejected this argument. It held that the clause was not a clause that required the participant to transfer cash or property on breaching the contract (which could potentially be a penalty clause), but instead, merely imposed (as a matter of contract) a condition precedent that had to be met before the participant would be treated as a good leaver. As the condition was not met, the participant was not treated as a good leaver. Therefore, the underlying rules of the deferred bonus plan applied, which provided that, in the absence of an agreement otherwise, the award lapsed on the participant ceasing employment.
This second limb of the decision is a helpful principle for companies operating incentive plans under which they have a discretion to treat a departing participant as a good leaver.
Where the breach comes to light before the award vests
Current best practice for share plan leaver conditions (particularly where a plan is subject to performance conditions) is that good leavers should not receive an early vesting, but instead should only receive vesting on the normal vesting date, at the same time as non-leavers (with performance targets being measured at that time and subject to any applicable time pro-rating provisions). It will therefore become increasingly common that there will be period between the leaving date and the vesting date, increasing the chance that employers may discover misconduct before awards vest.
The Imam-Sadeque case is directly relevant here, and gives comfort that companies can agree to treat a leaver as a good leaver but subject to set conditions being complied with.
As an example, the condition that can be imposed could be the general warranty, included in most compromise agreements, that the participant has not breached his employment contract. If it is found that the participant was in breach of contract, the company can refuse to allow vesting. It seems from the Imam-Sadeque case that, subject to the drafting of the compromise agreement, this principle can be applied to any material breach of the employment contract, even if the breach is not so serious as to amount to a repudiatory breach.
Going further, treatment as a good leaver can also be made subject to the participant complying with post-termination covenants (non-compete, non-poaching etc). The underlying covenants will be subject to normal scrutiny, but provided the covenants are enforceable, the company should be entitled to refuse to allow vesting if the participant breaches the covenants.
Is the case helpful where the misconduct is discovered only after vesting?
A more complex situation is where misconduct is only discovered after an award has already vested and the shares or cash have already been transferred. In order to recover value from the participant, the employer will need to bring a claim for breach of the employment contract (as well as breach of the compromise agreement if one was entered into).
Where the breach would have been serious enough to allow the employer to dismiss the individual summarily, such that the participant would have been a bad leaver under the incentive plan, the company should be able to claim for the damages it incurred in respect of allowing the award to vest.
Although the Imam-Sadeque case did not consider the issue directly, Mr Justice Popplewell did explore a helpful line of reasoning in support of his conclusion. Mr Justice Popplewell reasoned that because the participant had been in such serious breach, BlueBay could have summarily dismissed him for gross misconduct had it known at the time what it subsequently discovered. Had the participant been summarily dismissed, his award would have lapsed, and therefore Mr Justice Popplewell suggested the true value of the award to the participant was in fact zero.
Isn't there an easier way to ensure a company can reclaim value where misconduct is discovered?
A company can put itself in far stronger position by including a claw-back provision in its incentive plans, which will apply, at a minimum, in cases where the company discovers serious misconduct. Claw-back provisions are becoming increasingly common in share plans operated by listed companies in the UK. The ABI expects share plans to include claw-back provisions, and quoted companies may be required to introduce claw-back provisions by the next revision of the Corporate Governance Code.
Enforcing claw-back against a former employee can still be difficult, and the company may still need to bring proceedings against the individual, but a well-drafted claw-back provision will provide a strong contractual basis for that claim.
One concern in enforcing claw-back is whether or not the provision would be an unlawful penalty (a contractual provision will be an unlawful penalty if it provides for a payment to be made as a result of a breach of contract, where the amount of the payment is not a genuine pre-estimate of the loss caused by the breach, and where the clause is not justified in the circumstances). The Imam-Sadeque case is again helpful here as the Court considered arguments as to why, even if the clause in that case was a penalty, it would in any event have been justified and enforceable. The same reasoning supports the view that a properly drafted claw-back provision should also avoid being held to be an unlawful penalty. One factor in this decision was the difficulty to the company in assessing, and proving, loss caused by breach of employment duties. Another factor was the underlying policy considerations in favour of deferring remuneration. This is likely to provide an increasingly strong argument in support of claw-back provisions, not only for financial services firms but for all quoted companies as ensuring executives do not receive undeserved reward becomes an increasingly important political and policy issue.
The Court also emphasised the sophistication of the participant and relative equality of bargaining power. This is a factor that may be able to be applied in support of claw-back provisions, particularly in awards to more senior individuals, although it does remind companies of the importance of ensuring that claw-back provisions are brought to participants' attention, thereby reducing the risk of a challenge on the grounds that a participant was unaware of the clause.
Companies wishing to link the exercise of a discretion to treat a participant as a good leaver to a requirement that the participant complies with restrictive covenants can also make it far easier to enforce the agreement by delaying vesting until after expiry of the covenant period. This may be unpopular with the individual; however, covenant periods will normally be of 1 year or less which should mean the delay will not be overly onerous, and in any event the company is in a strong position as the award will lapse unless the company exercises the discretion. The power to delay vesting in this way is unlikely to be expressly included in a share plan (although plans could be amended in this regard), but in many plans the provision setting out the discretion to treat a leaver as a good leaver should be wide enough to give companies scope to delay vesting in this way.