Is the law an ass with employee share plans?

The law may be an ass but when it comes to employee share schemes, there are certain legal requirements that company directors, in particular, need to know about. Probably the biggest practical risk is that the share option arrangements may be questioned at a later date – for example, if the company is sold and the options are due to be exercised.

In some cases, there’s even a risk that company directors could be committing a criminal offence.

Here are some key points that directors need to consider when adopting employee share plans e.g. the Enterprise Management Incentive Plan (“EMI”) (or equity arrangements for non-employees):

  • General duties under the Companies Act: When making any decisions concerning the establishment or operation of an employees’ share scheme, the directors must have regard to their general duties owed to the company. In particular, they need to have regard to their duty to promote the success of the company for the benefit of its members as a whole and, in doing so, to have regard to (among other things) the likely consequences of any decision in the long term and the interests of the employees. All of the directors should consider their duties in this context, including reviewing the documentation and details of the plan. Clearly the easiest way to do this is to record the consideration of these duties in a board minute.
  • Complying with financial services law: If a non-employees’ share option arrangement is involved (e.g. consultant options such as a Deferred Share Purchase Plan), the same applies, but it is of particular importance that the board considers the impact of granting options to a non-employee, partly because of the Financial Services and Markets Act 2000 (“FSMA”) implications. Failure to comply with FSMA can be a criminal offence.
  • Directors’ interests and conflicts of interest: In addition, any director who has an interest in options to be granted must declare an interest in any proposed option grants. Again, this is usually best recorded at a meeting of the directors. Again, failure to comply with this can be a criminal offence.

So what?

Leaving aside the legal niceties, there are practical considerations that arise. In many cases, private company owners will be looking for an exit, commonly by selling the company to a third party. It’s usual for options to become exercisable at this point. Any potential purchaser of the company will be likely to scrutinise carefully the employee share option arrangements as part of the due diligence process. If matters haven’t been dealt with correctly, then the selling shareholders may suffer a “price chip” to the purchase price, or alternatively they may be required to enter into a specific indemnity to cover any issues arising (e.g. unforeseen tax charges). If this happens, it’s pretty certain that it will be the sellers that will “write the cheque”, not the buyers.

RM2 can help you meet these legal requirements at the time you set up your share plan, avoiding such future pitfalls. Contact us for a free consultation by emailing or calling 0208 949 5522.

If you are looking for a more in-depth read, consider ordering the book “Employee Share Schemes for Private Companies – A Guide for Directors”