Recruiting the right senior executive can be an immense benefit to a company if they bring the right mix of skills, experience, and contacts to the business.
During the recruitment process it is important to ensure that all terms, conditions and incentives are discussed and agreed to ensure an alignment of understanding. The agreed terms should be recorded in detail in a contract known as a service agreement.
Remuneration packages and contractual terms for senior executives can be complex. So, investing time and resources in the negotiations and in setting out the agreed terms is well worth it. Not doing so can prove costly, damaging to the business or the executive’s future opportunities and at worst, ends in litigation.
Directors and Companies Act 2006
The Companies Act 2006 sets out directors’ duties and the law on directors’ involvements in companies, and our corporate team can advise on all aspects of Companies Act requirements.
This article highlights a number of key elements in any senior executive’s service agreement and remuneration package and the employment law considerations.
Buy out from earlier role
In negotiating a package to move on from another organisation, executives may effectively ask their new employer to ‘buy them out’ from their existing role. This ‘golden hello’ is in essence compensation for any lost remuneration or benefits that would have been received if they had not jumped ship.
Employers may try to use this buyout to lock the executive into the contract for a period of time to recoup this cost.
Executives will want to ensure the buyout is protected in the contract, should the employer terminate their employment.
When negotiating notice periods, the executive may not want such a long period that it effectively hinders them from finding a new role. However, long notice periods can become a form of financial protection if the company terminates their employment. This is because, in practice, senior executives may not have to work out their notice period as their employer may wish to protect customer contacts, trade secrets or other business interests.
To have the best of both worlds, executives may seek to negotiate a longer period for the company giving notice and a shorter time if they resign. A directors’ notice period of more than two years must be approved by the shareholders.
Insurance and indemnities
Companies are restricted by the Companies Act 2006 in how far they can indemnify their directors against liability arising from the director’s actions. For example, the company cannot indemnify them against their negligence or breach of duty. Instead, board directors should consider if suitable directors’ and officers’ insurance is in place and ensure that this is reflected in the contract. It may be sensible for the insurance coverage to continue after the end of employment.
Bonus payments can make up a very significant part of the remuneration package, and also provide fertile ground for disputes over calculations.
Bonus provisions need to be crystal clear to ensure they reflect the deal agreed and to minimise the risk of disputes arising at pay-out time or on departure. The terms of the bonus or even the bonus itself may be described as discretionary.
The terms of entitlement to a bonus, and the way in which the amount will be calculated must be spelled out, for example if sharing a pool of cash based on a percentage of pre-tax profits or being based on personal performance or company profits.
Other incentive-based schemes, such as share option schemes and long-term incentive schemes also need to be carefully drafted, particularly for any ‘good leaver’ or ‘bad leaver’ provisions, which determine the executive’s entitlement on exit.
These are usually dealt with separately to the service agreement, and executives should obtain tax advice on these schemes.
The remuneration package may include other entitlements such as permanent health insurance, life assurance, private medical insurance, a car and associated running costs.
Any conditions attached to receiving such benefits, whether related to a time period or performance, need to be set out in detail.
There is a general implied duty to act in good faith towards the employer, which mostly ends when the employment ends, but contracts frequently restrict an executive’s outside business interests and activities in more precise terms.
Often more contentious, are any restrictions on exit. These covenants aim to prevent the executive from doing certain things after they have left the company which could be damaging to the company. These include working for competitors, poaching business or staff, accepting work from a client of the former employer or setting up in competition. To be enforceable, these restrictions must only go so far as necessary to protect the company’s legitimate business interests and must not be an unlawful restraint of trade. Therefore, it is recommended that restrictive covenants are carefully tailored to the specific circumstances. A generic set of restrictive covenants is unlikely to be of assistance to the company.
On a related note, companies frequently seek a warranty that the executive is free to work for the company and will not be in breach of any court order or contractual restriction with a previous employer. This is to protect the company in case it gets pulled into any litigation and accused of inducing the executive to breach their previous contract.
Pitfalls to avoid
Problems typically arise when it is not clear exactly what has been agreed between the executive and the company. This may be because the detail was not worked through at the start of the relationship or was not set down properly in writing, or a combination of the two. For example:
- What benefits or bonus, if any, is the executive entitled to receive when given a payment in lieu of notice?
- Can the company withhold a payment in lieu of notice if it discovers it could have sacked the executive for gross misconduct?
- Is it clear in what circumstances an executive would be a bad leaver or a good leaver for determining the price paid to a departing executive for their shareholding?
- Are the restrictive covenants specific to the individual’s activities, going no further than necessary to protect specific legitimate business interests?
- Do references to a long-term incentive or bonus scheme inadvertently create a contractual right or limit the discretion of the board?
How we can help
We advise both companies and executives on negotiating packages and ensure the agreed terms are properly captured to minimise the risk of a future dispute. For further information, please contact Andrew Masters, Head of Employment, on 01227 763939.
Please note: This article is for general information only and does not constitute legal or professional advice.