When negotiating the terms of settlement agreements for senior executives, much of the initial focus is often, understandably, placed on the headline financial figures (for example, notice pay, compensation payments and the treatment of bonus / commission). However, share / equity awards may well make up the lion’s share of the value (or potential value) of a settlement package. In this article, we set out six key questions senior executives should ask themselves when considering the treatment of share awards on exit. We then briefly consider some of the constraints to negotiation that must be considered, particularly in relation to directors in a public company context.
Are you a “good leaver”?
The default position in many share plans is that unvested share awards lapse on termination of employment. However, it is worth checking whether you should or could be treated as a “good leaver”. Typically, plan rules have a concept built into them which provides that if your employment is terminated for certain specified reasons (sometimes literally, and other times colloquially, referred to as “good leaver” reasons) then your awards will not lapse, and different treatment will apply (see point 2 below).
There are certain “good leaver” reasons that feature in many share plans, such as where employment terminates due to the participant’s death, ill-health, injury, disability, redundancy or where the business or company in which the employee works is sold out of the group. Retirement is also often included in these specified lists of reasons in older style plans. Therefore, consider whether the circumstances of your termination mean that you should be treated as a “good leaver”.
In addition, there is often a broad discretion within the rules to allow the company to treat an individual as a “Good Leaver” in any other circumstance which they consider appropriate. Even if you are not, by default, a “Good Leaver” consider whether there is scope to negotiate that you will be treated as such as a consequence of exercise of discretion in your favour.
When do your awards vest?
If you are treated as a “good leaver”, the treatment of your awards will differ depending on the type of plan. Generally there are two different options:
Your awards will vest early, usually immediately on termination of employment, or
Your awards will continue to vest on the normal vesting date according to their original timeline. It is often the case that one of these options is the default position, and the company has discretion to provide for the alternative option. In both cases, awards may also be subject to time pro-rating (see point 3 below).
Depending on the type of award and the participant’s circumstances at the time, each option can produce different benefits. In some circumstances (particularly if the rules provide that awards vest in full), there could be significant benefit in receiving awards early, in which case exercising the discretion to accelerate awards could be a particularly valuable position to seek to negotiate. On the other hand, where awards are subject to performance conditions, there could be value in allowing awards to run on until their normal vesting date, so that performance testing can be carried out on a “wait and see” basis, rather than on termination when the awards may be of little value or underwater given the performance targets will not have been met at the time of termination.
It is therefore important to review the rules to see what the default position is and whether there are any discretions that could be exercised in your favour.
Will your awards be pro-rated?
As mentioned above, where a participant is treated as a “good leaver” and allowed to retain their awards, it is often the case that the award will vest subject to time pro-rating, unless the company exercises its discretion to determine otherwise. Time pro-rating essentially means that the number of shares subject to an award are reduced to reflect the period of time that the participant has remained in employment, as compared to the original vesting period (ie the period of time over which an award would usually vest). Plan rules often contain a discretion to allow the company to determine that time pro-rating will not apply or will apply to a lesser extent. Clearly, if agreed, this can be of significant value to a participant.
Bear in mind that executive directors of publicly listed companies will be subject to the terms of the remuneration policy and so the parameters of this policy should be considered before negotiation begins (see “remuneration policy” below).
When does your employment terminate for the purposes of your share awards?
Clients often assume that for the purpose of any share awards, employment is treated as terminating on the last day of your employment. However, that is not always the case. We increasingly see share plans including a discretion to allow the company to treat a participant’s employment as ending on the date they give (or receive) notice of termination of employment or when they are placed on garden leave. Where this is the default position, there is commonly a discretion for this to be disapplied. But why is this relevant?
Many share awards will be granted on the strict condition that they vest over a period of time referred to as a vesting period (for example, three years). The award may vest in tranches during, or all at once at the end of, that period. If employment terminates before that vesting period is complete (ie before the award, or part of an award, vests) then the award will usually lapse on termination of employment. However, if you are treated as a “good leaver” such that your award does not lapse, the difference between the start of any period of notice and the date your employment actually ends may have an influence on whether, or how much of, your award vests (and / or the level of time pro-rating that will apply) and how much value you are therefore able to retain. Equally, many share awards will be granted subject to performance conditions (ie objective criteria that must be satisfied before an award can vest). If that is the case, and similar to as stated at point 2 above, allowing your award to run-on for the length of your notice period may allow, or increase the extent to which, performance conditions are satisfied.
Therefore, it’s important to consider when the default trigger date is for termination of employment in the share plan and whether there is a discretion that could be exercised in your favour. This is particularly likely to be of relevance to executive directors of public companies who typically have long (often 12 month) notice periods. If you have a long notice period, there may be significant value in negotiating a period of garden leave during your notice period (rather than a payment in lieu of notice) if that will allow a greater proportion of your share awards to vest.
Will your awards be subject to a post-vesting holding period?
A post-vesting holding period is an additional period of time (typically two years from vesting), during which time the shares subject to an award will usually not be delivered to participants (or if the shares have been delivered, the shares remain subject to restrictions on dealings). Generally, at the end of the holding period, shares will be released to participants (or become free of restrictions). On termination of employment, plan rules typically provide that holding periods continue to apply as usual following vesting, but there is often a discretion for the company to disapply this requirement. If early release of the underlying shares could be of benefit to you, it’s worth exploring whether the company would be prepared to exercise their discretion to allow the holding period to be disapplied.
Note, however, that this is less likely to be agreed where you hold shares in a public company due to the guidance from the Investment Association which specifically emphasises the importance of holding periods (see “Investment Association Guidance” below). Similarly, executive directors of public companies may also be subject to a post-employment minimum shareholding restriction.
Does the company have the right to buy back your shares?
In private company share schemes, where shares are a less readily tradeable asset and where the company will want to restrict the number of employee held shares to those actively working in the business, the company will often have the right (although not an obligation) following termination of employment to buy back a leaver’s shares subject to a vested award. Whether or not this is of value to a participant will depend, among other aspects, on:
The value of the company and therefore the value attributable to the leaver’s shares, at the time, and
The liquidity that the company has available which will impact the company’s ability to fund the buy-back.
There are three points to be aware of here which are important to address in negotiations:
- An “exit” event may be envisaged in the short to medium term which may result in the delivery of enhanced value to share plan participants on that exit,
- The company may have the ability, in the share scheme rules, to delay any buy-back payment, or pay in instalments, and
- A mechanism for valuation of the shares will likely have been included in the share scheme documents and, if that was deviated from, the price received could affect the employee’s tax position (for instance, if receiving more than market value for the shares).
We have set out below a high-level summary of two key sources of constraint that may need to be factored into settlement negotiations, particularly in a public company context. In addition, for regulated businesses there may also be further constraints (for example in banking and financial services, within the relevant remuneration code).
For directors of a publicly listed company, the extent of any negotiation will be constrained by the terms of any shareholder approved directors’ remuneration policy in force from time to time (“remuneration policy”). For UK incorporated quoted and unquoted traded companies (which does not include AIM-listed companies), there are restrictions in the Companies Act 2006 which prevent any payments or benefits being provided to directors which are inconsistent with the remuneration policy and, if remuneration terms are offered which are inconsistent with the remuneration policy, they will be void and any inconsistent payments made will be held by the director on trust for the company (unless an amendment to the remuneration policy is approved by shareholders which authorises the payment).
The policy will likely dictate the timing of vesting on termination of employment (particularly, whether vesting can be accelerated), the circumstances in which pro-rating can be disapplied (or conversely, when pro-rating will apply), the application or disapplication of any holding periods and, among other points, will usually provide guidance around the exercise of any discretions available to the company or its remuneration committee.
Further, quoted and unquoted traded companies will be required to explain in the directors’ remuneration report how any discretion was exercised in relation to payments or other incentive awards to outgoing directors, which may also impact the company’s approach.
Investment Association Guidance
The Investment Association (“IA”) periodically publishes a set of principles on executive remuneration and long-term incentives. The principles of remuneration are designed to give companies clarity on members’ expectations on executive pay. Although the guidance is predominantly relevant for companies with a main market listing, it is also relevant to companies listed on other public markets, such as AIM. Whilst they are non-statutory, they are regarded as a key indicator of best practice and good corporate governance and, consequently, the principles often factor into the remuneration policy itself.
If you are a director of a public company, it is important to consider the terms of any remuneration policy when considering what may be possible to negotiate and, in any event, to have an eye on the IA’s principles of remuneration and how this may influence negotiations.
Our market-leading senior executive team frequently assists clients negotiating exit agreements. Our clients include public company directors, founders, directors of private companies (often in private equity backed businesses), bankers, other professionals in financial services and other C-suite executives across industries. There is no one-size fits all approach to our advice. We offer personalised, tailored advice to our clients based on decades of experience acting for the most senior individuals within corporates across many different sectors. For more information contact Eleanor Rowswell and view our senior executive brochure here.
If you require further information about anything covered in this briefing, please contact Natasha Nichols or your usual contact at the firm on +44 (0)20 3375 7000.
This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.
© Farrer & Co LLP, December 2022