Three doors

Did you know that unless an express right is set out in a shareholders’ agreement or articles of association, shares cannot be ‘taken off’ a director or employee who leaves a company, no matter how big the cloud under which their departure occurs?

For this reason, investors will insist on their investment documentation including compulsory transfer provisions setting out the circumstances in which a shareholder can be required to offer their shares for sale to the other members. This will usually include a variety of situations such as bankruptcy, death, breach of the investment documents and cessation of employment.

Good or bad leaver?

A person’s employment can come to an end in a range of different ways. They may voluntarily resign or retire, or they may be dismissed, perhaps because they’ve failed to perform to the required standard or possibly for more sinister reasons such as gross misconduct or fraud.

As a result, the investment documentation will usually draw a distinction between ‘good’ leavers – those who could be considered to be at no fault – and ‘bad’ leavers – those who are in some way in the wrong. Good leavers will usually receive the fair market value for their shares but bad leavers can expect to receive a reduced amount (typically, only the nominal value of their shares) in order to reflect their perceived wrongdoing.

Are bad leavers unfairly penalised?

Concerns are sometimes expressed about the enforceability of bad leaver provisions, given that they can produce a harsh result for the leaver: whilst it might be fair to require them to give up their shares and not participate in any future growth, is it also right that they receive no value for any growth up to the date of their departure, growth to which they have contributed whilst employed at the company? Could that be construed as an unenforceable penalty which fails to reflect the actual loss suffered?

New guidance from the courts

A recent case* has helped to shed some light on how the courts will view bad leaver provisions. In this case a director was dismissed and compulsory transfer provisions applied. The case focused on whether they were a bad leaver for the purposes of the investment documentation meaning they would only receive the nominal value of their shares.

The judge held that the director was guilty of gross misconduct and had been justifiably categorised as a bad leaver. The judge went on to state that there was no reason for the court to interfere in the consequences of that categorisation since those were contractual arrangements made between the parties. This was so even if it produced a “harsh, even draconian, result” for the director.

Reassurance from the court

The judge made some reassuring comments about bad leaver provisions, noting that they represented a readily understandable balance between the reasonable expectations of an executive shareholder and the protections required by investors. Provisions for the removal of a director and the deemed transfer of their shares at a price depending on the circumstances of their departure were not offensive to the nature of a company as a small corporate body based on personal relationships.

There was no reason why the contractual provisions should not be given effect – although the judge did say that the provisions should be strictly interpreted and should not be used for ‘unworthy purposes’.

Good for investors; bad for executives?

The decision in this case will be welcomed by investors as confirmation that one of their key weapons in dealing with departing executives will be recognised by the courts. And executive shareholders should beware the consequences of departing ‘under a cloud’ and ensure that bad leaver provisions are drafted as narrowly as possible from the start.

*Moxon v Lichfield & ors [2013] EWHC 3957 (Ch)


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This blog is intended only as a synopsis of certain recent developments. If any matter referred to in this blog is sought to be relied upon, further advice should be obtained.