Serious misconduct discovered after termination can be used to justify summary dismissal and may result in the employer justifiably withholding certain statutory and contractual entitlements.

A recent decision by the NSW Court of Appeal's decision is a timely reminder that employees, particularly those in executive positions, must fulfil their contractual and statutory obligations. Failure to do so may amount to serious misconduct, entitling the employer to dismiss the employee summarily and potentially withholding contractual entitlements, including bonuses.

In Downer EDI Limited v Gillies [2012] NSWCA 333, the Court of Appeal overturned a decision by the Supreme Court which saw a former executive awarded more than $7 million in damages. President Allsop (with whom Justices Macfarlan and Meagher agreed), found the former executive had engaged in serious misconduct when he, albeit with honest intentions, borrowed or "advanced" money from his accrued bonus account without notifying the board, not taking into account tax obligations, and without regard to the reputational risks to which he was exposing his employer.

The executive's employment

Stephen Gillies was employed by Downer EDI Ltd in 1988 until his termination in 2007. For the last 10 years of his employment, Gillies held the positions of managing director and chief executive officer.

Over the years, Gillies was considered to be a most valued employee, whom the Board had relied on to build the business into a multi-billion dollar enterprise.

He was given certain entitlements within this position by way of his contract of employment. These included a bonus plan, capped at 50 percent of his annual salary ($1.5 million at the time of his termination), as an additional benefit under the executive share option plan. These share options were available to Gillies up until 2000. After this time, the Phantom Option Scheme (POS) was introduced which gave the managing director all of the benefits available under the share option plan without issuing of shares or options (which dispensed with the requirement to report the arrangement to the ASX and shareholders).

The bonus Gillies was entitled to was announced each year. These bonuses accrued over time as Gillies opted to delay drawing on them – a decision seemingly based on tax considerations.

In August 2007, following a downturn in profits, the board passed a no-confidence motion on Gillies, who was stood down from his position, and ultimately dismissed.

Downer later relied on alleged misconduct to justify the dismissal, although the evidence of misconduct was discovered after Gillies had left its employment.

Alleged misconduct

The alleged misconduct regarded money which Gillies borrowed, or "advanced", against his accrued bonus. It was accepted that in 2002 Gillies and Downer's chief financial officer arranged for two payments of $450,000 and then $1.2 million to be transferred to Gillies to allow him to buy a boat. Gillies viewed these payments as advances on his bonus, which did not need to be repaid (although he did pay back the amounts), while the CFO viewed these payments as loans taken from the bonus account. The problem was that these transactions were not board approved, the second payment overdrew the bonus account by $200,000, and Downer was left with an unfunded tax liability.

The second incident which allegedly amounted to misconduct related to a number of transactions in 2006 and 2007 totalling over $750,000 which allowed Gillies to purchase a property in New Zealand. He arranged through the CFO (who by then had been appointed as finance director) for deposits to be made in New Zealand currency into Gillies' New Zealand account. There were understood to be withdrawals from his bonus account. He subsequently drew cheques for the amounts in Australian currency, which were understood to be repayments to his bonus account. The Court of Appeal described the arrangement as a "short term unsecured loan in foreign currency".

Although the finance director claimed that there was a practice of allowing senior employees to utilise Downer's "treasury function" for private reasons, there was no evidence of this practice.

Whether Gillies had engaged in serious misconduct had significant monetary impact, as the contract stated that the termination payments (which included three months' notice and bonuses) "will not be payable in any case where the termination is effected under Clause 4.1(c) due to your misconduct or fraudulent activity."

Supreme Court decision

There were a number of issues before the Supreme Court, which were later taken up on appeal. Relevantly, the court had to determine:

  • was the POS ratified, and was it binding and effective;
  • when did the employment relationship between Downer and Gillies come to an end;
  • if the POS was binding and effective, was Gillies employed when he made his election to withdraw all money from the bonus account (the answer to which flowed from the second question);
  • did Gillies engage in serious misconduct during his employment, such that by clause 4.3 of the contract or the general law, he had no right to the termination payment; and
  • was Gillies indebted to Downer in respect of a loan for a car?

Justice Rothman ultimately found in favour of Gillies on all accounts.

He found that the POS was incorporated as part of Gillies' contract and, importantly, that the alleged misconduct was not dishonest, improper or inappropriate – Gillies "did not exploit his position as CEO for personal gain at the detriment of the shareholders."

Decision on appeal

The five questions outlined above were put to the Court of Appeal, which unanimously found in favour of Gillies on four of those but, importantly, it found that he did engage in serious misconduct during his employment, and as such was not entitled to the termination payment (calculated to be in excess of $7 million).

It found that Gillies' conduct was incompatible with due and faithful discharge of his duties as the most senior executive in the company, judged within the legal framework in the Corporations Act.

The court found that:

"Gillies was obliged to exercise his powers and discharge his duties with a reasonable degree of care and diligence in Downer's circumstances (s 180), in good faith (including honestly) in the best interests of Downer and for a proper purpose (s 181), and he was obliged not to use his position improperly to gain an advantage for himself or to cause detriment to Downer (s 182). Further, by his position as a director of a public company, Mr Gillies was a related party of Downer (s 228). As such, for Downer to give Mr Gillies a financial benefit (as described in s 229), unless the benefit was remuneration (s 211) or the amount was below that prescribed by regulation, being $5,000 (s 213), the approval of Downer's members was required."

The conduct had to be assessed objectively, and although honesty and motive may be relevant, Gillies' understanding of his justification for being paid large sums of money by Downer was "entirely lacking in proper justification". This was particularly so where Gillies took no steps to acquaint himself with the basis of his entitlement, or indeed what amount he was entitled to.

The court found that Gillies' use of his position was objectively improper as it related to the boat payments as well as the New Zealand currency transaction:

  • there was an improper use of Downer's funds (albeit with an assumed claim of right);
  • the funds were for personal use; and
  • the transactions exposed Downer to risk of damage and contravention of tax and corporations legislation (even if Downer did not sustain a financial loss due to the transactions).

Gillies had further submitted that even if he had engaged in serious misconduct, his termination was not effected because of that conduct, and as such, he was entitled to the termination payments. The Court of Appeal, however, enforced the long-standing common law principle that a contracting party is not deprived of a justification which existed for a contractual position, whether it was known at the time or not. It held the use of the word "effected" includes effected as a matter of law, and is broader than the historical fact of what occurred.

As such, given the wording of the contract, the court found that Gillies was not entitled to the termination payments.

Implications

The Court of Appeal's decision reinforces that:

  • executive employees may have contractual, statutory, and possibly fiduciary obligations to act in the best interest of their employer;
  • conduct will be assessed objectively. While subjective honest may be relevant, "there is no haven for the morally obtuse"; and
  • serious misconduct discovered after termination can be used to justify summary dismissal and may result in the employer justifiably withholding certain statutory and contractual entitlements.