Employee incentives on termination of employment

10th January 2013

The High Court recently considered the impact of the actions of a former employee during garden leave on the terms of his compromise agreement, including his deferred incentive awards. The decision provides useful guidance to employers.

In the case of Imam-Sadeque v BlueBay Asset Management (Services) Ltd, the High Court considered a claim by a former employee (who had resigned voluntarily) for satisfaction of a deferred incentive award. The relevant compromise agreement provided that the employee should be treated as a “good leaver” (and should therefore retain the award), as long as he satisfied the obligations contained in his employment contract and the compromise agreement (which extended to the period of his garden leave). However, in subsequently disclosing confidential business information to one of his employer’s competitors and assisting in the recruitment of a former colleague to work for the competitor, the High Court held that the employee was in repudiatory breach of contract and was, therefore, not entitled to the unvested award. While the extent of an employee’s duty of fidelity during the period of garden leave might depend on the facts of each case, the Court found that, on the facts of this case, it was not reduced.

The Court also had to decide a second question. The compromise agreement provided that the employee must fulfil certain obligations in order to keep his “good leaver” status, and therefore avoid losing his deferred incentive award.  Should this provision properly be treated as a “penalty clause”? By way of explanation, a penalty differs from liquidated damages in that it is intended, broadly, to apply unreasonable force to a party who is potentially in breach to perform his obligations, rather than to compensate an innocent party for a breach of contract. A penalty would not be an enforceable term of his contract.

The Court found that the compromise agreement did not provide for the employee’s rights to the award to be forfeited on breach. Under the terms of the deferred incentive award plan, he lost his rights when he resigned from his employment, and it was not argued that this provision was unenforceable as a penalty. The compromise agreement conferred a conditional benefit which did not accrue because he did not satisfy the condition. There could be no penalty issue if the benefit had not yet accrued. Further, a clause can only constitute a penalty if there is no commercial justification for it and the Court was reluctant to find in this case that there was no commercial justification.

There are several key points here for companies operating employee incentive plans.

  • A compromise agreement can usefully provide that an employee should act in the best interests of the employer at all times. The Court found that such a provision was broad enough to cover competitive activities.
  • A compromise agreement can also usefully include an express obligation on the employee to be bound by the terms of his employment during garden leave. This can be an important protection as the extent of the duty of fidelity during garden leave is open to question.
  • The inclusion of a provision in a compromise agreement making the vesting of the award expressly conditional on satisfactory performance of the employee’s obligations is effective to reinforce the terms of the employment contract.
  • The penalty doctrine should not normally be relevant in the case of unvested incentive awards. The position might, however, be different in relation to leaver provisions in articles of association or in stand-alone agreements for the transfer or allotment of shares, because this is more likely to concern rights which have already accrued (that is, shares or share rights that are already owned) .