Take a typical situation: the chief executive is summoned to a meeting with the chairman who tells him that the majority of directors have decided he must go. He is asked to resign as a director immediately but is assured that his contract of employment will be honoured in full. The chairman spells out what this will mean. He is told to find himself a lawyer. The company will cover his legal fees. If he does not resign, he will be dismissed.
The director would prefer to resign only when the deal is done. The company cannot wait. He is asked to leave the premises. So what next?
The director almost always questions whether the chairman has authority to remove him. In most cases he does not — it will depend on what the articles say about how a director can be removed. However, even if the rules are being broken, in reality the majority of directors acting together will be able to force a resignation through.
So should he resign? His service agreement may state that if he resigns as a director, his employment will automatically terminate. If he does resign as a director, it will be wise for that resignation to state expressly:
- his contract of employment remains in full force and effect;
- he is resigning in reliance on the company’s representations that his contract will be honoured in full; and
- his resignation is without prejudice to his legal rights.
Obtaining the company’s written agreement to these terms is preferable, but not always forthcoming.
The pressure exerted by public limited companies stems from the Financial Services Authority listing rules. These require that the company must notify any change in the board, including the resignation of a director, and the effective date of the change, if it is not immediate, as soon as possible and in any event by the end of the business day following the decision. So there is no time to lose.
The package
The executive may take great comfort in the chairman’s promise to honour the contract, but the chairman may have promised more than he can deliver. Section 217 of the Companies Act 2006 (replacing section 312 of the 1985 Act) provides that the approval of the members is required for payments made to directors or former directors as compensation for loss of the office of director or loss of any other office or employment (i.e. not merely loss of office, as previously) with the company or in connection with his retirement. On the other hand, under section 220 (replacing section 316), no such approval is required for a payment made in good faith:
- in discharge of an existing legal obligation (but not one entered into in connection with, or in consequence of, the event giving rise to the payment for loss of office);
- by way of damages for breach of such an obligation.
The civil consequence for breach of these sections is that the payment is held by the recipient on trust for the company making the payment, and any directors who authorised the payment are jointly and severally liable to indemnify the company for any loss resulting from it.
Payment in lieu of notice (PILON) clauses in service agreements have become more aggressive as a result of the combined code on corporate governance and pressure from institutional investors. Many provide for payment of no more than basic salary in lieu, with nothing for benefits. Others provide for payment by instalments and even deductions for mitigation. In this regard it is worth considering the following:
- Is the PILON clause expressed to be in full and final settlement of all claims the director has? They do not always do this and if not, it gives greater scope for arguing that while the payment in lieu is defined, there are other claims (for example in relation to bonus) that can still be made;
- Are there statutory claims the director can make that entitle him to compensation? Even if the PILON clause provides that payment is in full and final settlement, this cannot preclude statutory claims that the director can bring as an employee. Claims as an employee can enable the director to claim for future loss not covered by the PILON;
- If there are mitigation provisions in the PILON, how aggressive are these? Some require the director to take reasonable steps to mitigate. Others only require the director to keep the company informed of other earnings;
- Will fees from all non-executive directorships be deductible under the mitigation clause? Increasingly, public companies encourage main board members to have one or two non-executive appointments, and therefore continuing to receive fees for these after termination may not be deductible from the PILON.
Delayed termination
Quite often employment is not to terminate immediately (say, for example, there is to be a lengthy period of gardening leave, or the executive is going to be retained for a period of handover). You may find yourself presented with a double compromise agreement: one to be signed immediately and the other to be signed on or about the termination date.
The reason for this is, of course, that the company wishes to ensure that any claims that might arise between the date on which the first compromise agreement is signed and the termination date are also settled prior to payment of the compensation. If the employee is on gardening leave, perhaps the risk of new claims arising is relatively small. If, on the other hand, the employee is still working, the risks may be greater.
These kinds of agreements present special considerations all of their own:
- Assuming all the benefits are conferred upon your client in the first compromise agreement, but conditional upon the signing of the second agreement, what is the mechanism for ensuring that the company is bound into executing the second agreement (the employee having settled his obvious claims under the first agreement)? How secure is the position of the employee in the meantime?
- It is typical for the second agreement to be scheduled to the first. How is this obligation drafted, at a time when the company is trying to protect itself against unknown claims or events which have not yet arisen? Has the company reserved the right to amend its terms and, if so, how extensively? Is there a danger of the arrangement being too vague, and void for uncertainty?
- Is it fair that, having ascertained the amount of compensation to be paid on the basis of known claims, unknown claims are then rolled into the settlement for nothing? What, potentially, is the executive giving up?
- Will there be any legal costs associated with the second compromise agreement and, if so, has provision been made for them?
- Where is the consideration for the second agreement? In the context of statutory claims, this may be of academic interest, because the provision of section 203 of the Employment Rights Act 1996 will bar statutory claims in any event. But it may be relevant to your client in the context of common law claims.
- Is there an entire agreement clause in the second agreement? The second compromise agreement must specifically reserve the executive’s rights to claim under the first.
Inevitably, most companies will dismiss a director at some point. When it comes to a parting of ways, the legal issues outlined above should be dealt with as quickly, expertly and discreetly as possible.
Elaine Aarons is a principal and Jane Richards a consultant in the employment team at Withers.