The lawfulness and enforceability of bad leaver provisions

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Posted in:HR and Employment|November 13, 2014 | Join the mailing list


Good and bad leaver provisions have become commonplace in Shareholders’ Agreements, Employee Share Schemes and Articles of Association. They are used to incentivise employees who are shareholders, as well as deter key shareholder employees from leaving.

The purpose of good and bad leaver provisions is usually to categorise who will be considered a “good” leaver and thus benefit from receiving the market value of their shares on departure, and who is considered a “bad” leaver and receive only a nominal value
when they leave. A good leaver will usually be considered to be an employee who retires, dies in service, is incapacitated through ill health or is unfairly dismissed. A bad leaver is usually an employee who departs under a cloud (for example as a result of
dismissal for gross misconduct or going to work for a competitor) and as such, the employer does not wish for them to benefit from their departure.

In the 2013 Court of Appeal decision in El Makdessi v Cavendish Square Holdings BV and another [2013] EWCA Civ 1539 (“El Makdessi”) the Court of Appeal cast doubt as to whether bad leaver provisions are always enforceable in the way in which they were intended.
By their nature it is extremely unlikely that there would be the same need to examine a good leaver provision for its enforceability.

Although not considering good and bad leaver provisions per se, in El Makdessi, the Court of Appeal overturned the High Court’s decision and found that clauses in the share purchase agreement constituted unenforceable penalties. The case sets out four questions
to ask when considering whether a clause in a commercial contract could be deemed as punitive:

•    Was there a commercial justification for the clause?

•    Was the clause extravagant or oppressive?

•    Was the predominant purpose of the clause to deter a breach?

•    Were the terms of the contract negotiated on a level playing field?

The one certain outcome of El Makdessi is that, when it comes to contractual clauses, it cannot be a one size fits all policy. This is demonstrated by Moxon v Litchfield and others [2013] EWHC 3957 (Ch) where, despite a bad leaver provision being harsh, even
draconian, it was held that as the clause had been properly negotiated and had commercial justification the clause was still enforceable. However, where the negotiation has not been on a level playing field, and where the clause lacks commercial justification,
there is the potential for a Court to find that a bad leaver provision is punitive in nature and as a result, following El Makdessi, unenforceable.

This highlights the importance of taking time and appropriate advice to properly negotiate contracts. Where a bad leaver provision has clear commercial justification without being overly oppressive and has been properly negotiated, it is likely to be enforceable.

Should you have any queries regarding the subject matter of this article, please contact
Keith Kennedy, Partner in the
Corporate and
Commercial Department, at
keithk@berg.co.uk, or by telephoning 0161 833 9211.
      
The information and opinions contained in this article are not intended to be comprehensive, nor to provide legal advice. No responsibility for its accuracy or correctness is assumed by Berg or any of its partners or employees. Professional legal advice should
be obtained before taking, or refraining from taking, any action as a result of this article.

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