Bad leaver provisions not unconscionable or a penalty

Bad leaver provisions not unconscionable or a penalty

Bad leaver provisions not unconscionable or a penalty

In the recent case of E Nosworthy v Instinctif Partners Ltd the Employment Appeal Tribunal has highlighted that “bad leaver” provisions that required an employee who voluntarily resigned her employment to forfeit shares and loan notes were not unconscionable and did not amount to a penalty clause.

Facts

Miss Nosworthy (“N”), started working for Communication Operations Ltd (“COL”) in September 2011. COL was sold to Instinctif Partners Ltd (“IP Ltd”) in July 2013. In connection with that acquisition, N was given 2% of the share capital of COL (equity was given to key employees to ensure continuity post-acquisition). She then sold those shares to IP Ltd under a share purchase agreement, which provided for both initial and deferred consideration. The deferred consideration included entitlement to earn-out shares and loan notes, subject to “good/bad leaver” provisions contained in the share purchase agreement, other agreements and the Articles of Association. 

The definition of “bad leaver” under the Articles included a seller who voluntarily resigned their employment. The bad leaver provisions provided that IP Ltd would be entitled to acquire the leaver’s shares at the lower of the acquisition cost or fair value. The bad leaver would also be required to forfeit his or her loan notes in whatever way the Remuneration Committee (acting reasonably and in good faith and with a view to tax efficiency) may determine. 

N resigned with notice in May 2016.  IP Ltd, relying on the Articles, treated N as a bad leaver.  N was informed that she would receive the lower of the acquisition cost and the fair value of the shares as determined by the Remuneration Committee.  She received the acquisition cost of £1 per share (£143 in total) and was required to forfeit her loan notes.

N brought a claim in the employment tribunal for breach of contract and unlawful deduction from wages. She claimed that the bad leaver provisions were unenforceable as they were unconscionable, were in breach of the rules against penalties and contravened the Modern Slavery Act 2015 because the forfeiture provisions constituted forced or compulsory labour. She also claimed that the Remuneration Committee had acted in bad faith.

Decision

The tribunal rejected all of N’s claims. In particular, the tribunal rejected the argument that the contract was illegal under the Modern Slavery Act 2015.  N had taken up employment voluntarily, and resigned when she no longer wished to work for IP Ltd. Compulsory labour was not involved.

N appealed to the Employment Appeal Tribunal (EAT). The EAT rejected all elements of N’s appeal. In particular, the EAT found the following:

Breach of contract – tribunal jurisdiction

Employees have the right to bring breach of contract claims against their employers in the employment tribunal where they either arise or are in existence on the termination of their employment and they are not one of the specifically excluded claims. In this case, the EAT held that N was able to bring her claim under the tribunal's jurisdiction to hear breach of contract claims as the share purchase agreement in question was a contract "connected with employment".

No unlawful deductions

The unlawful deductions regime deals with sums payable to workers in connection with their employment. The EAT confirmed that it does not cover any payment to the worker “otherwise than in their capacity as a worker”. Although the claim in respect of the shares and loan notes could be said to be payable in connection with N’s employment, the shares and loan notes were deferred consideration for the sale of N’s shares and they were provided to her in her capacity as seller of shares (not as a worker). The tribunal had therefore been correct to dismiss N’s complaint of unlawful deduction from wages. 

No unconscionable bargain

In order for a bargain to have been unconscionable, each of the following must be true:

  • one party must have been at a serious disadvantage whether through poverty, ignorance, lack of advice, or otherwise;
  • the other party had to have exploited that disadvantage in some morally culpable manner; and
  • the resulting transaction would have to be overreaching and oppressive. 

The EAT held that, in this case, not even the first limb of the test was met. N was not at a serious disadvantage. There was no evidence that she had been unable to take legal advice and in fact had warranted in the share purchase agreement that she had taken professional advice and that the bad leaver provisions were reasonable.  

No duty of good faith

N argued that the Remuneration Committee had acted in bad faith by not exercising its discretion and reclassifying her as a good leaver. The EAT refused to look beyond the clear wording of the Articles in answering that question. An employee who gave notice to terminate their employment was a “bad leaver” under the express terms of the Articles and questions of good faith were not relevant.

Not a penalty clause

On penalties, N argued that giving notice to terminate her employment contract caused IP Ltd no loss, therefore the imposition of a penalty of forfeiture of the loan notes and repurchase of the shares at minimal value was out of all proportion to any loss caused by her breach of contract in being a bad leaver. The EAT dismissed this. The EAT noted that the rule against penalties was confined to remedies arising on a breach of contract. The definition of “bad leaver” did not depend on there being a breach of contract in this case as the bad leaver provisions were applied as a consequence of the application of the terms of the Articles. Therefore, the penalty doctrine did not apply.

Comment

This case should give buyers confidence that bad leaver provisions are generally robust and that it is possible to hold individual sellers to the bad leaver terms even where that leads to a rather draconian result for a selling employee shareholder.

It does, however, show the importance of allowing prospective employee shareholders to take independent legal advice on the effect of the bad leaver provisions, especially where the bad leaver provisions cover resignations, not just dismissals for cause.

Although the bad leaver provisions in this case did not entail a breach of contract, in other scenarios they may do so and therefore be within the penalties rule.  For example, “bad leaver” provisions in a shareholders’ agreement have been held by a court to be subject to the rule on penalties. If the consequences of breach of the relevant provision are exorbitant or unconscionable, this could cause problems on enforcement.

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