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Bad leaver provision is not a penalty and is enforceable

Companies often set out bad leaver provisions in their articles of association or shareholder agreements to distinguish between the share price payable to an individual who is a good leaver (usually limited to retirement and redundancy) and bad leaver (of course for dismissal for misconduct/performance, but usually for any reason that is not a good leaver, including resignation).

The commercial courts have considered a good number of cases to test whether bad leaver provisions could be seen as a penalty and therefore unenforceable and a recent case in the Employment Appeal Tribunal has now dealt with a similar issue.

Background

In the case of Nosworthy v Instinctif Partners Ltd an employee began working for the company in 2011 and then in 2013 the business was acquired by a sale of shares. It was a condition of sale that equity was provided to key employees, including the claimant, in the form of deferred earn-out shares and loan notes. Qualifying employees agreed not to be bad leavers as part of the transaction and, if they were bad leavers, to transfer at cost any shares they had already received and forfeit their loan notes.

Employees who voluntarily resigned were to be classified as bad leavers under the agreement. When the claimant later resigned, she brought a claim for breach of contract on the basis that the bad leaver provisions were unenforceable as they were unconscionable, in breach of the rule against penalties and contravened the Modern Slavery Act 2015.

The employee claimed this represented an unauthorised deduction from wages. The EAT disagreed, stating that payments relating to the earn-out shares and the loan notes were made to the employee as a seller of shares and not as a worker and could not be classed as unauthorised deductions.

The EAT said the bad leaver provisions were not unconscionable as the employee had not purchased the shares but had been gifted them as part of the sale process. It also ruled that applying the bad leaver provision did not depend on breach of the promise not to be a bad leaver, which meant the rule on penalty clauses was not met as there was no breach of contract.

The EAT also ruled that the bad leaver provisions were clearly drafted and therefore rejected the claim that the buyer had acted in bad faith.

Notes for employers

Both employer and employee must be clear about what they are signing up to when bad leaver provisions are put in place.  In this case, the clarity of the agreement was one of the key things that influenced the EAT’s decision, even though the definition of a bad leaver was wider in this case than is usually seen. The company had given careful thought to the circumstances under which its employees would benefit from share incentives and these had been set out in a clear way.