COMPENSATION UPON TERMINATION OF APPOINTMENTS OF DIRECTORS AND SENIOR EXECUTIVES

COMPENSATION UPON TERMINATION OF APPOINTMENTS OF DIRECTORS AND SENIOR EXECUTIVES DIRECTORS ADVISORY SERVICE FACTSHEET These Guidance Notes provide an outline of the relevant provisions, but they are not comprehensive and should not be relied on as authoritative. Specific advice should be obtained on any particular issues. Areas of protection On the termination of the appointment of any employee, including executive directors and senior executives, there are two main areas where such a person can look for protection being their contract of employment and statute. In the event of the employer not dealing with the termination of employment in accordance with the protections given by the contract and statute, this is likely to give rise to various claims for compensation. Who qualifies for compensation? Under the contract of employment any employee (including an executive director) is likely to be eligible for compensation if the termination of employment by the employer is a breach of the contract of employment. The contract of employment may be contained in more than one document. All of the terms may not necessarily be in writing and additional terms may also be implied into the contract. Certain terms (even if in writing) may be overridden by statute such as the statutory right to a minimum period of notice. Under statute any employee (including an executive director) may be eligible for compensation if: a) they have been employed for the qualifying period which is now at least two continuous years at the date of dismissal if employed on or after 6 April 2012 (or one year of continuous employment if employed before that date) and:- the reason for dismissal is not one of the five potentially fair reasons for dismissal under employment legislation; and/or the company has not adopted a fair and reasonable procedure in coming to the decision to dismiss for that reason; or b) the dismissal is for a reason which gives rise to a claim of discrimination under one of the nine protected characteristics defined in the Equality Act 2015 Institute of Directors. All rights reserved. 1

2010 which are age, disability, gender reassignment, marriage and civil partnership, pregnancy and maternity, race, religion and belief, sex and sexual orientation; or c) the dismissal is for another protected reason, for example trade union activity. To make a claim under b) or c) above there is no qualifying period of employment. The employee will not be eligible for compensation if the employment is terminated because the employee: Resigns of his, or her, free will; Acts in a manner that destroys the relationship of employer and employee e.g. gross misconduct, gross negligence. What acts of an employer give rise to compensation claims? Contractual Claims Breaches of the employee s contract of employment on the part of the employer may include: Failure either to give the correct period of notice, or to make payment in lieu of notice (which would include salary and in some cases depending on the wording of the contract, compensation for loss of contractual benefits that the employee would have been entitled to receive during the notice period); Failure to make payments due under the contract up to the date the employment terminated; A unilateral variation in the employee s contract by the employer without the employee s consent; Breach by the employer of an implied term, for example the duty of trust and confidence, showing that the employer no longer intends to be bound by the contract (sometimes referred to as repudiatory breach ). Depending on the circumstances this may amount to a constructive dismissal. Statutory claims A claim for unfair dismissal is likely to arise unless the dismissal is for one of the five potentially fair reasons for dismissal which means that the reason must be related to:- the conduct of the employee the capability of the employee the redundancy of the employee s role; or 2015 Institute of Directors. All rights reserved. 2

the fact that the employee could not continue to work in the position being held without contravening legislation; or some other substantial reason of a kind such as to justify the dismissal of an employee holding the position which that employee held. Even if an employer has one of the potentially fair reasons for dismissal as described above it is still necessary for the employer to show that the dismissal was fair in all the circumstances (including the size and administrative resources of the employer s undertaking). Being fair in this context generally means that the employer has to demonstrate it adopted a proper procedure in coming to the decision to dismiss for the reason that it did. Dismissal related to one of the nine protected characteristics referred to above, trade union activities (including independent unions such as staff associations), for whistle-blowing or for asserting certain statutory rights are all likely to lead to a claim for unfair dismissal. Note: We have referred to the proper procedure that an employer must adopt in order to make a potentially fair reason for dismissal actually fair. What is an appropriate procedure will depend on the reason for dismissal. The procedure and timescale that is required in circumstances of redundancy will be different to a dismissal for capability. Detail of the procedure that an employer is required to adopt in order to ensure that a dismissal is fair within the meaning of the legislation is beyond the scope of this Factsheet and both employers and employees are advised to take legal or HR advice and to review guidance given on the ACAS website www.acas.org.uk. Compensation The purpose of compensation is to restore the employee to the position he, or she, would have been in (as far as this can be done by money) were it not for the actions of the employer. Depending on the particular circumstances and the terms of the contract when considered in the context of the above outline, the following may apply: Contract Compensation may be claimed for loss of salary and contractual benefits including pension contributions that should have been made by the employer up to the date of termination as well as holiday that has accrued but not been taken. Depending on the wording of the contract, compensation may also be claimed for bonuses and commissions up to the date of termination. In addition, and again depending on the wording of the contract a claim may be made for salary and other contractual benefits that the employee would otherwise have been entitled to during the notice period, had the notice been worked. These might include loss of a company car (or car allowance), medical insurance and the company s contribution to the employee s pension scheme. There is no additional claim for compensation in relation to the loss of holiday or holiday pay during the notice period as this is considered to be paid as salary. 2015 Institute of Directors. All rights reserved. 3

The employee is under a duty to mitigate loss (by finding alternative employment) and the employer may attempt to impose a reduction on the compensation payable (or pay the compensation by instalments) to take this into account. The employee may also have rights under a share option scheme and these should be checked. Statute If the employee has a potential claim for unfair dismissal, compensation is likely to be sought based on compensation that might be awarded by a Tribunal in the event of a claim being made. This is likely to include: a) the basic award for unfair dismissal (calculated in the same way as statutory redundancy and based on age and length of employment); b) a compensation award (currently capped at 76,574* or one year s salary whichever is the lower amount) which is intended to compensate the employee for their losses including loss of earnings up to the date of the hearing and potential future loss of earnings; c) compensation for loss of the right to claim unfair dismissal (because the employee will have to serve out a further qualifying period with any new employer). In the case of a dismissal due to a discrimination reason (one of the nine protected characteristics described above), special rules govern compensation and it is uncapped. There are also other supplementary areas where an employee may seek compensation such as where the employer has failed to issue a statement of employment particulars or has breached various other regulations. If a Tribunal considers that an employer has unreasonably failed to follow the guidance set out in the ACAS Code of Practice: Disciplinary and Grievance Procedures, it can increase any award it has made by up to 25%. * this figure valid in respect of dismissal occurring on or after 1 st April 2014. The figure is reviewed each year and will rise to 78,335 for dismissal occurring on or after 1 st April 2015. Reductions The employee has a duty to minimise ( mitigate ) his, or her, loss. This would include: Accepting alternative equivalent employment offered by the employer; Seeking employment elsewhere; Using his, or her, experience to set up in business. Expenses incurred in mitigating loss e.g. job hunting may be recoverable. 2015 Institute of Directors. All rights reserved. 4

If a Tribunal considers that an employee has unreasonably failed to follow the guidance set out in the ACAS Code of Practice; Disciplinary and Grievance Procedures, it can reduce any award it has made by up to 25%. Payments under Heads of Compensation above may be reduced by the amount of any ex-gratia payment made by the employer. Note: Compensation is generally not awarded in respect of mental distress; injured feelings; loss of reputation relating to the manner of dismissal but compensation may be awarded if such damages were caused as a result of the employer conducting the business in a manner liable to reflect on the employee or for example if the employer has suspended the employee for an unreasonable period of time prior to dismissal or if the dismissal is due to a discriminatory reason (one of the nine protected characteristics described above). Additional Awards There are various circumstances when a Tribunal can make an additional award such as when an employer does not comply with an order to reinstate the employee. The subject of additional awards is beyond this Factsheet. Written reasons Employees who have sufficient continuous employment to qualify for unfair dismissal are entitled to receive, if requested, a written statement setting out why they were dismissed. Taxation Compensation payments may usually be made without deduction of income tax up to the exemption limit of 30,000 in aggregate in respect of: Genuine ex-gratia payments made in full and final settlement of all claims against the employer; Payment of salary in lieu of notice unless the employer has the right under the contract of employment to make a payment in lieu in which case the sum will be subject to normal deductions for income tax and employee s national insurance contributions; The undertaking of the employee not to take legal proceedings, or bring further claims against the employer, or to discontinue legal proceedings already commenced; Statutory redundancy payments and, subject to the necessary conditions, payments from non-statutory redundancy schemes; Compensation ( damages ) awarded by Employment Tribunals and Courts ; Payments that are taxable include: Payment of salary in lieu of notice by an employer who has this right under the contract of employment; 2015 Institute of Directors. All rights reserved. 5

Undertakings going beyond the settlement of the employee s existing claims and rights e.g. restrictive covenants given on termination of employment but which are not in the contract of employment; Deferred remuneration; Payments to employees who are given notice and sent on gardening leave by an employer who has the right under the contract of employment (this is because an individual on gardening leave will continue to be an employee and will therefore be paid salary and taxed as an employee). Note: Detailed discussion of the taxation of compensation is outside the scope of this Factsheet. Employers and employees are advised to consult their tax advisers or HMRC concerning exemption and such matters as where it might be possible to spread cash or benefits forward into more than one tax year. Termination of Directorships Both non-executive and executive directors may have a contractual entitlement to compensation for loss of office. There is no separate statutory entitlement to compensation for loss of office it must be in the contract and it is relatively rare these days. In cases where such a contractual entitlement exists, the compensation payable is additional to any payable in respect of termination of employment of an executive director and it will be taxable. In the case of an executive director, compensation may be payable in respect of any breach by the company of the employment contract under which the directorship is held. In the case of a non-executive director, compensation may be payable in respect of any breach by the company of the contract under which the non-executive director was appointed. Payments of certain types and exceeding certain amounts made to directors upon termination of their appointments must: Be approved in advance by the shareholders; Be disclosed in the company s accounts. Even so, payment may be enforceable if there is a contractual obligation to make it. Reaching a Settlement 1. An executive director or senior executive may be faced with one of two situations when the employment is terminated: The offer of what appears to be a reasonable severance package, usually with the condition that a settlement agreement (previously known as a compromise agreement) is signed; or No offer of compensation - or an offer that is unacceptable. 2015 Institute of Directors. All rights reserved. 6

2. If a reasonable package is offered it may be possible to add to it, or to substitute for parts of it, such matters as the following according to personal priorities: Utilising any tax free exemption applicable (see above); Enhancement of pension rights (by paying part or the whole of any settlement into pension); Outplacement counselling; Other form of training; A reference in an agreed form of words. 3. If negotiations conducted by either the employee in person, or for the employee by solicitors specialising in employment law, are unsuccessful a choice may have to be made in respect of contractual claims between bringing proceedings before an Employment Tribunal, County Court or in the High Court. Prior to filing a claim at an Employment Tribunal, a prospective claimant is required to contact ACAS to complete and submit an Early Conciliation Form. This step is mandatory but the decision to participate in early conciliation is voluntary for both the applicant and the respondent. Further information is available from ACAS www.acas.org.uk The maximum award that Tribunals may make in respect of claims for wrongful dismissal (i.e. breach of contract) is 25,000. In respect of dismissals that occurred after 1 st February 2014, the maximum compensatory award that Tribunal may make in respect of unfair dismissal is 76,574 or a year s salary whichever is the lower amount. This figure is reviewed up or down annually depending on the RPI. In addition to the compensatory award, if there is a finding of unfair dismissal a Tribunal will also make a basic award which is calculated in the same way as a statutory redundancy payment based on age, length of service and weekly salary capped at the statutory maximum (currently 464) and again reviewed each year. Since August 2013 a claimant making an application to an Employment Tribunal has to pay fees on the issue of the claim (which will vary from 160 to 250 depending on the nature of the claim) and a hearing fee between 230 and 950. In certain circumstances the claimant and the respondent may have to pay additional fees see www.acas.org.uk In an Employment Tribunal each party is normally responsible for its own costs no matter who is successful. Costs do not follow the event as they do in civil courts. Tribunals have increasing powers to make costs orders and advice should be taken but an award of costs remains the exception rather than the rule. Accordingly, in cases where the anticipated contractual claim lies just beyond the Tribunal s limit of 25,000, an important consideration may be that the legal costs incurred by the successful employee are generally not 2015 Institute of Directors. All rights reserved. 7

recoverable from the unsuccessful employer in cases heard by Employment Tribunals. Employment Tribunals have the power to order an employer who has lost a case at Tribunal to pay a financial penalty of between 100 and 5,000 where the employer has breached the rules with aggravating circumstances. Compensation for claims where it is shown that the employer discriminated against the employee, contrary to the relevant legislation, is unlimited. All claims to Employment Tribunals must normally be brought within three months of the date of dismissal or the date of the action triggering a claim. This time limit may be extended in certain very limited circumstances. It will also be extended by up to 6 weeks if the parties are participating in Early Conciliation through ACAS (see above). Settlement Agreements (previously known as Compromise Agreements) Settlement of an unfair dismissal claim that is reached without a hearing before an Employment Tribunal will be binding only if: A conciliation officer of ACAS has exercised his, or her, statutory power; or A statutory valid Settlement Agreement is entered into, following receipt by the employee of legal advice from a relevant independent advisor, usually a barrister or solicitor. Note any compensation payment made to a director (or anybody connected with such director) for loss of office or employment which exceeds the company s existing legal obligations (both contractual and statutory) to that director will require shareholder approval. Note: The IoD cannot act for a Member for such purposes, but the Advisory Service will be glad to discuss the matter and suggest solicitors specialising in employment law. Alternatively, members may use a Find a Lawyer facility, offered by Law Express, provider of the IoD legal helpline, Directors Law Express, www.iod.com/lawexpress. This Factsheet is one of a series produced by the IoD Directors Advisory Service. it is intended as a general introduction to the subject, and is not a definitive guide. If you would like specific advice, please contact the Directors Advisory Service on 020 7451 3188, businessinfo@iod.com. The service is free and is exclusive to members of the IoD. 116 Pall Mall, London SW1Y 5ED May 2015 2015 Institute of Directors. All rights reserved. 8