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Are Bad Leaver Provisions Enforceable?

12 April 2019

In the case of Nosworthy v Instinctif Partners Ltd, the Employment Appeal Tribunal (EAT) has set out circumstances where it considered that Bad Leaver provisions will be enforceable and not be unconscionable or amount to a penalty.

Background

In 2013, the Respondent, Instinctif Partners Limited, acquired Communications Operations Limited (COL). As a condition of the sale and for the purpose of post-acquisition employee retention, COL awarded shares to its employees. Ms Nosworthy (the Claimant) who was an employee of COL, entered into a Share Purchase Agreement (SPA) under which she was to receive an initial cash sum out of the total sale proceeds with the remainder of the consideration for her shares received in the form of loan notes and earn-out shares (the Deferred Consideration).

The Deferred Consideration was subject to Bad Leaver provisions in the SPA and Articles of Association of the Company respectively. These stated amongst other things that if an employee voluntarily resigned from COL whilst any of his or her Deferred Consideration remained outstanding, then such employee would forfeit his or her loan notes and be required to transfer his or her shares at the lower of the acquisition cost and fair value of the shares.

In August 2016, the Claimant resigned from her employment with the Respondent and shortly after, was served with a notice requiring her to transfer her shares to the Respondent at the acquisition cost of £1 per share. She was also deemed to have forfeited her loan notes pursuant to the terms of the SPA and the Company’s Articles of Association.

In the first instance, the Employment Tribunal held that as there had been no bargaining or negotiating in relation to the purchase of the Claimant’s shares—i.e. the Claimant had effect been gifted the shares, it could not be said that the Bad Leaver provisions were unconscionable.

The Employment Tribunal further held that by resigning from her employment, Ms Nosworthy had not been in breach of her employment contract and therefore, the Bad Leaver provisions did not amount to a penalty.

Judgement

Dismissing the Claimant’s appeal and finding the Bad Leaver provisions to be enforceable, the Employment Appeal Tribunal (EAT) held that:

  • Bad leaver provisions will not be deemed to be unconscionable unless there had been some serious disadvantage such as poverty, ignorance or lack of legal advice. Whether or not a Claimant sought independent legal advice at the time of the share award would not suggest that he / she did not have access to legal advice at that time. In this case, the Claimant had sought independent legal advice in relation to the share purchase so could not satisfy the requirements for establishing unconscionability. Also, there was nothing in the facts presented before the EAT which suggested that the Claimant had been coerced into accepting the shares in COL.
  • Where an employee becomes a Bad Leaver for any reason other than as a result of a breach of contract, the relevant Bad Leaver provisions will not amount to a penalty. Under her employment contract, the Claimant was entitled to voluntarily resign from her employment with the Respondent at any time. By resigning, the Claimant had not been in breach of contract and therefore the Bad Leaver provisions had applied because of the terms of the Company’s articles and not because of any breach of contract.

Relevance

Bad leaver provisions are often drafted into Company’s Articles of Association or Shareholders’ Agreements to govern situations where employees hold shares in the Company. These usually provide for the employee to transfer his or her shares back to the Company or to the existing shareholders when he or she leaves. These provisions are important as they help avoid the situation where employees who leave employment with the company for a competitor (or for any other reason) continue to hold shares in the company.

Where employees hold options over shares instead of actual shares in their employer company or the parent company within a group, it is helpful to include Bad Leaver provisions in the share scheme documents to ensure that employees who leave the Company during a specified period (as pre-determined by the Directors) do not benefit from the scheme after they leave unless the directors decide otherwise. Whether or not an employee will be considered a Bad Leaver will depend on the Leaver provisions in the Company’s articles or in the relevant share scheme documents.

Before implementing any employee share scheme, including the direct award of shares to employees, business owners and directors have to consider the terms under which employees who hold shares in the Company will be required to transfer their shares on leaving. In the Nosworthy case, the EAT stated that provided Bad Leaver provisions are clearly set out in the Company’s articles, they will be enforceable regardless of how “curious” they may be.

Whilst the Company’s articles may provide for directors to have discretion to determine whether an employee is a Bad Leaver or a Good Leaver at the time of leaving, the certainty provided by clearly setting out circumstances where employees will be Bad leavers in the articles or scheme documents cannot be overstated.

Pett, Franklin & Co. LLP are experts in employee share schemesexecutive incentives and share valuations. To find out more about we how we can help you or your client, please contact Stephen Woodhouse at stephen.woodhouse@pettfranklin.com or call 0121 348 7878.

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