Employee Share Schemes - acquiring shares after exercise

Posted by RM2 at 09:33 on 12 Apr 2019

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The recent case of Nosworthy v Instinctif Partners Ltd (2019) UKEAT/0100/18 is not strictly speaking a case regarding employee share schemes but a couple of the themes are pertinent to our arena, particularly where employees have acquired shares following the exercise of share options, or under an employee share plan. The case itself related to a sale transaction which involved deferred consideration (in the form of loan notes and shares in the purchasing company). The articles of association of the purchasing company contained relatively usual “Bad Leaver” provisions whereby someone who resigned (amongst other “Bad Leaver” potential scenarios) would be required to sell their deferred consideration shares back to the company for the value paid for the shares in question. In this case, that would have been nominal value. (Loan notes were also forfeit but that position wasn’t considered in detail.)

The claimant sought to argue that she should be allowed to keep the deferred consideration shares under a multitude of grounds (including an application of the Modern Slavery Act!). The most interesting to RM2 of these grounds were as follows.

Firstly, the Employment Appeal Tribunal ("EAT") held that the claimant could bring her claim under its jurisdiction as the share purchase agreement (for the sale of the company) was a contract “connected with employment”.

The claimant sought to argue that her resignation on notice had caused the purchaser/respondent no loss. As a result, the compulsory repurchase of the shares at nominal value was out of proportion to her “breach of contract” as a “bad leaver”. This invoked the “rule against penalties” principle – in summary, a contract can’t have a clause that penalises a party over and beyond any loss that might have been suffered. However, the EAT viewed matters rather differently and stated the rule against penalties principle was not relevant here because the consequences (as set out in the articles of association) did not rely on the claimant being in breach of contract in any case (referring to the Supreme Court decision in the case of Cavendish Square Holdings BV v Talal El Makdessi [2015] UKSC 67). The purchaser/respondent in this case was merely relying on the provisions of the Articles of Association. The EAT also noted that the claimant had taken independent legal advice in relation to the sale documentation.

Secondly, the EAT held that the “bad leaver” provisions written into the articles did not reflect an “unconscionable bargain” in this case (which would have required exploitation in a morally culpable manner that was overreaching and oppressive!).

The case is a useful examination of the “penalty clause” area relatively recently re-affirmed in the Supreme Court in the Makdessi case mentioned above.

It is noteworthy that the EAT did not (because there was no relevant breach of contract) consider whether the consequences of being a bad leaver in this case were in fact out of proportion to the company’s legitimate expectations. Naturally though the purchaser/respondent would have been seeking to ensure that certain key employees were incentivised/retained after completion.

If your company is setting up an share plan for employees, one of the key points you’ll need to consider is how to manage leavers. RM2 can help advise on how to deal with leavers in a situation where shares have already been acquired by employees – for example, via the exercise of an Enterprise Management Incentive ("EMI") option or the acquisition of shares under a Share Incentive Plan ("SIP") - or where an optionholder ceases employment before options are exercised. Give RM2 a call on 0208 949 5522 or email enquiries@rm2.co.uk