As reported in our previous Law-Now, the Department for Business Innovation & Skills (BIS) last year introduced draft legislation requiring listed (but not AIM) companies to hold binding shareholder votes on directors' pay. It also provides for a further, but non-binding, shareholder vote on the implementation of pay policy and enhanced remuneration disclosure in annual reports and on websites.
After a gap of some months, we have now seen what is likely to be the final substantive debate in Parliament on the relevant legislation. There were some Government amendments, but Opposition proposals, which would require 75% rather than 50% support for a company's pay proposals to take effect and annual rather than three yearly policy votes, were rejected.
There have also been ancillary developments. After much criticism of the first draft, a revised set of draft supporting Regulations has been published (click here to see the new draft Regulations). These set out the detail of what companies will need to include in their new-style remuneration reports when the legislation comes into effect, although there has been further consultation on this and the final version has yet to be published. The Government has also published a set of FAQs (click here to see the FAQs). For the purpose of the new rules, pay or payment normally includes the receipt of shares as well as cash.
This Law-Now summarises these recent developments and the current position.
When payments are affected by the policy
When does the legislation take effect for companies?
The principal change to the legislation since it was first introduced has been to bring forward the operation of the legislation for some companies. It will now affect companies' accounting periods which begin on or after 1 October 2013 - so the first companies that will be affected by the legislation will be those whose financial year ends on 30 September 2013, rather than (as was first thought) those whos financial year ends on 31 December 2013. If your company is a September year end company and you intended to copy what others had already done, that luxury will no longer be available. You will now be a leader rather than a follower.
Other amendments have also been made to plug loopholes which have been pointed out to BIS and to clarify when "payments" to directors are first required to comply with the voted policy.
As stated above, the legislation comes into force on 1 October 2013 and affects a company's first financial year to begin on or after that date and subsequent years, but the Government recognised that the provisions restricting director pay could not take effect immediately when the first financial year starts. This was because the relevant policy vote under the new regime cannot be held until an AGM, and an AGM will be at the earliest several months into the first financial year affected by the legislation.
BIS' position on this is as follows. Companies have some choice: payments need only be made in accordance with the binding policy from the start of the second financial year of the company affected by the legislation, but companies can operate it earlier.
So, assuming a December year end company, directors’ payments would be caught at the latest on 1 January 2015 (ie the start of the second year of operation), but if the company's first policy vote under the new regime (which would normally be held in May 2014) specified an earlier date, the policy could become binding earlier. It is not yet clear whether companies will want to specify an earlier date. They cannot specify one before the 2014 AGM, as that would capture payments which had already been made before the policy vote, but the obvious candidate seems to be the date of the 2014 AGM itself, although it will be interesting to see what market practice becomes.
What if a company can't pass its policy vote in the first year?
While extremely unlikely, failing your vote in the first year could have extremely serious consequences. BIS says that if companies fail their remuneration policy vote in their first year, and do not manage to pass a subsequent vote by the end of that year, they will not be able to pay their directors from the second year of the legislation's operation until shareholder approval for payments has been received. While we dispute BIS' reading of the legislation, this shows how serious the first year's vote will be. If a later vote is failed, at least a company can fall back on the previously approved policy. However, with the first vote BIS argues there will be no policy to fall back on. The fact that option schemes/LTIPs have already been approved by shareholders does not override this.
Other "payment" issues
In all cases, the relevant policy to comply with is the policy at the time of payment, not at the time the arrangement to make the payment was agreed (although there are limited exceptions for arrangements agreed before September 2012). BIS confirms that payments made after takeovers (when a company has delisted) do not have to comply with the policy (unless exceptionally the bidder is listed, when the payment may have to comply with its policy), but in practice the Takeover Code already prevents any material departure from pre-agreed arrangements.
However, it is important that the policy covers all expected aspects of remuneration for directors (both executive and non-executive) with room for sufficient flexibility so as to comply with the law, yet sufficient precision to meet shareholder expectations and enable the vote to be passed. If changes are provided for within the policy, then that should be acceptable and treated as consistent with the policy, but companies need to be careful to make sure it remains consistent with the policy.
Statutory employment rights are not caught
One interesting point that the BIS guidance confirms is that payments sourced in statutory employment rights are outside the scope of the legislation. This was clearer in the first consultation, but the revised legislation oddly omitted addressing it. The lack of legislation on the point remains unhelpful though and, if this is what BIS intends, it would be preferable for it to be expressly stated. BIS' view may well encourage ex-directors to claim for redress under their statutory rights so as to avoid the caps imposed by the new legislation (what would seem principally relevant here could be age or sex discrimination), possibly even with the acquiescence of their companies.
Exoneration of directors
A number of directors have been worried about their personal liablity. The legislation has been amended to provide that directors can be relieved from liability where they have acted honestly and reasonably (slightly wider that the "honest mistake" reason that BIS describes this under) and a court in its discretion agrees. The problem here was that if any "payment" in breach of the policy was not recovered from the director concerned, then the remaining directors could be pursued for this. It is unclear whether D&O policies would cover this, and companies should check this because although a court can now offer relief so that a director is not liable, companies and directors will still prefer the safety of their D&O policies, rather than have to go to court for reliefs.
One useful clarification has been that, when directors leave, companies only need to make one announcement of what the director can receive thereafter. There was a concern that announcements would need to be made each time an ex-director received a payment (or shares). BIS' announcement refers to the first announcement saying how payments were calculated but it would appear that so long as a company explained what conditions and contingencies were involved at that stage, a single announcement would suffice even though payments may not then be quantifiable.
In terms of the contents of the report, there have been numerous changes although the substance remains as in our earlier Law-Now. These are necessarily detailed issues, which are only summarised below:
- A number of disclosures have been moved from the policy report to the implementation report.
- The summary at the start of the policy report must include key changes from the previous report as well as "key messages".
- When providing set values for projected and past remuneration (to enable comparisons to be made across years and across companies) and TSR comparisons, a number of valuation approaches have been amended to encompass the recommendations of the Financial Reporting Council on these issues. However, many companies still remain sceptical that these figures show any meaningful data.
- Performance targets for annual bonuses are now required to be disclosed unless "seriously prejudicial to the interests of the company", but once a bonus has been paid, targets will now have to be disclosed, without any ability to restrict disclosure on commercial confidentiality grounds.
- A specific maximum salary for potential new hires has to be disclosed (but just a general description not actual limits on other elements of the package).
- All payments (whenever made) to former directors are now caught.
It is hoped that a final draft of the reporting requirements will be published later in the Spring.
Now that the draft legislation is in near final form, companies need to start their transition to the new regime in earnest, working closely with their remuneration consultants on how their remuneration arrangements fit with the new rules and whether they should be changed.
For a link to our previous Law-Now please click here.