Joined-up contracts for senior staff

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Making sure that their employment documentation - contracts, policies, handbooks and the like - fits together properly is not just a matter of employers ensuring the various sources of contractual terms and workplace rules are consistent, do not conflict and reflect the way in which it wishes to regulate its relationship with its staff. Careful structuring of employment documentation should also be a priority for employers who want to control their exposure when parting company with senior executives who enjoy material notice periods and potential bonus entitlements.

Case law developments

Several recent high-value employment disputes have been based on the identifying and interpreting the terms of employees’ contracts. In Attrill v Dresdner Kleinwort the employer was held to be contractually bound by a promise given orally by a senior executive in an announcement made at a ‘Town Hall’ briefing to establish a specific level of bonus pool. This demonstrates the danger of verbal statements overriding the employer’s documented position or creating new separate entitlements for employees.

In Société Générale v Geys, the employer paid the executive in lieu of notice but was held not to have fulfilled the requirements of the specific pay in lieu of notice (PILON) provision by making the requisite payment but not making the prescribed notification to the employee of what it was doing. Consequently, the executive was able to establish that what the employer thought was a dismissal was actually a breach of contract which the executive could reject - with the consequence that he was entitled to considerably greater compensation based on what he was entitled to contractually at a termination date later than that intended.

The Geys case tells us, at the very least, that a PILON clause needs to be carefully and precisely drafted and its provisions followed to the letter to ensure that the dismissal is valid. Even if the executive does not argue that a purported dismissal is invalid on the basis of a failure properly to operate a PILON clause, the employer may nonetheless lose the benefits of any restrictive covenants in the executive’s contract as a result of a dismissal which is (technically) wrongful, even if full contractual compensation has been paid, because dismissal was not effected in compliance with the provisions of the clause. 


A properly drafted PILON clause will avoid any ambiguity, not only about when payment is made, what written notice is required and how the two interact - especially if the employer has the ability to pay in instalments. A PILON should identify how the payment is to be calculated in a precise way that is not open to challenge. Simply providing in the contract that the employer can pay in lieu of notice is unclear as to the calculation of the payment. A ‘salary only’ PILON clause will be the simplest to operate and builds in some degree of mitigation by not incorporating compensation for benefits otherwise due during the notice period - but for that reason may not be acceptable to an executive who may argue that, if the employer wants to be able to terminate immediately and without breach of contract, it should make a full notice payment.

The employer may therefore wish to craft a provision which compensates for benefits otherwise due to the employee during the notice period but is sufficiently precise to be as immune as possible to challenge in its application to calculate the payment due. This may be done by providing that the PILON will consist of salary plus the cost or value of the provision of the relevant benefits to the extent they are not actually continued. Even those formulations can be criticised so care is needed in the detailed drafting.

But what if the employer does not wish to include a PILON clause? The employer may take this view because the inclusion of a PILON clause precludes the application of the £30,000 tax exemption on termination payments from the notice element of a severance package. This is an academic issue if the severance payment to be made in addition to the notice period exceeds £30,000 as the exemption can then be applied in full to that additional element of the package. But if that is not the case, the availability of the £30,000 exemption may be curtailed when its availability could have facilitated a lower settlement based on the effect of the tax break.

In the absence of a PILON clause, as immediate termination without notice would be a breach of contract, a detailed garden leave clause will often be appropriate to allow the employer to ‘bench’ the employee during the notice period and control/monitor (to the extent possible) the individual’s activities by requiring that he or she remain contactable, be available to answer queries, etc. (See my thoughts in ‘Is garden leave overrated?’) However, the employee will remain employed and may therefore argue that he or she remains entitled to participate in any applicable bonus schemes. Similarly, if the individual employee is dismissed immediately without proper cause and therefore in breach of contract, he or she may seek to add loss of bonus into any damages claim or argue that bonus should form part of a PILON.

Bonus schemes

It is therefore important for employers to ensure that the consequences of termination of employment for bonus entitlements are properly addressed in the employment contract and/or applicable scheme rules and do not fall through the cracks leaving the employee with a potential damages claim. Of course an employer cannot contractually prevent an employee from including loss of bonus in the compensation sought in a statutory unfair dismissal or discrimination claim. Nonetheless, it often makes sense for the employer to make the position clear in its contracts and bonus schemes whether the bonus scheme is formulaic or discretionary. It may therefore be sensible to provide that the employee loses any entitlement to any payment on dismissal or indeed service of notice by either party. That said, not least in the context of formulaic bonus arrangements, it may be appropriate to provide that, despite termination of employment, in certain circumstances the employee should retain some entitlement, perhaps pro rata to the proportion of the bonus year actually worked, as a ‘good leaver’. The employer may consider that this good leaver treatment should be discretionary or should also specifically apply in certain defined circumstances such as redundancy, termination of employment by reason of incapacity and the like. As an aside in this context, allowing good leaver status on retirement presents potential issues of age discrimination by treating the (presumably older) retiree more favourably than a younger employee who resigns - careful consideration is needed on this point.

Share options

The need to control exposure on termination also arises in relation to share options. An employee who enjoys a long notice period but loses his or her options, for example, on summary dismissal because he is not treated as a good leaver either automatically under the scheme rules or by way of any exercise of the employer’s discretion, may seek to bring a damages claim for the loss of any increase in value of the relevant shares over what would have been the notice period. This will not be an issue if termination is effected validly under a PILON as there will then no breach of contract that can give rise to such a damages claim. But the risk will arise in a wrongful dismissal situation. The usual way in which this is dealt with is an ‘exclusion clause’ in the option scheme rules. Such clauses have been held to be valid (at least under the law of England and Wales) and prevent the employee from recovering damages for loss of the future increase in value of the options during what would have been the notice period. As these exclusion clauses are a UK invention the employer may end up exposed if extends to its employees participation in a plan operated by an overseas entity in its group, e.g. a US parent company which does not include such any exclusion as standard. The documentation used in the UK may need to reflect this point.


All this means that employers need to ensure consistency across their contract and bonus documentation and to put in place the right combination of flexibility and protection to ensure both that they can effect termination in the way most suited to their business interests but also can ensure that their exposure to termination costs is as they wish it to be.


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