Terminating a senior executive or director
Possible claims
In determining the level of any severance package that you might wish to pay the executive, you should first consider the claims that they might bring on termination of their employment. The most likely ones are a contractual claim for wrongful dismissal and statutory claims, mainly unfair dismissal and/or discrimination. If the reason for termination is redundancy, the executive will also be entitled to a statutory redundancy payment.
Level of compensation
In many cases, you’ll want an executive to leave employment immediately. To avoid a wrongful dismissal claim, you’ll have to pay them in lieu of notice (assuming there’s been no gross misconduct or gross negligence). If they have a large salary and a long notice period, e.g. six months or more, the sum that you’re liable to pay them in lieu of notice will be large, as you’ll need to reflect the net value of salary and other contractual benefits (such as bonuses, company car, holiday pay and pension scheme contributions) to which they would have been entitled had they been permitted to work out their notice period.
Pro advice. Where the director’s service agreement (see Follow up ) or employment contract contains a pay in lieu of notice (PILON) clause (see Follow up ) that you rely on in terminating the contract, they will be entitled to be paid out the full amount of their notice pay as a contractual debt (unless there’s provision for phased payments), without any obligation to mitigate their loss. However, if specifically allowed for in the PILON clause, phased payments, normally on a monthly basis over what would have been the notice period, can introduce an element of mitigation into the PILON payment. This is because they enable you to deduct from the monthly instalments any income that the executive receives from alternative employment (but note that they’re not under a duty here to take steps to seek alternative employment). You can’t implement phased payments unilaterally though.
Pro advice. If relying on a PILON clause, make sure you notify the executive in clear and unambiguous terms that their employment has terminated immediately in accordance with that clause.
Pro advice. Check whether the PILON clause enables you to limit the pay in lieu sum to basic salary only, i.e. excluding a sum in respect of other contractual benefit entitlements.
Pro advice. If there’s no PILON clause, what you’re paying amounts to damages for breach of contract to put the executive in the position they would have been if the contract had not been breached, i.e. if due notice had been given. Beware that this will usually result in any restrictive covenants being unenforceable (see below). In damages cases, the executive is under a duty to mitigate their loss by seeking alternative employment, so this gives you some room to negotiate on the appropriate settlement and to reduce the damages that would otherwise be payable.
If the executive has been employed for two years or more and there’s a need to exit them swiftly without following a fair redundancy, disciplinary, performance management, etc. procedure, or you don’t even have a potentially fair reason for dismissal, you’ll additionally have to pay them an amount by way of compensation to reflect not only the potential claim that they may have for unfair dismissal, but also the commercial advantage of your securing an amicable and quick departure. The same applies if the reason for termination relates to an Equality Act 2010 protected characteristic, e.g. sex, race, etc., but regardless of the length of the executive’s employment, i.e. you’ll need to buy out any potential discrimination claim.
Settlement agreement
Offering a severance package to the executive will normally necessitate opening pre-termination negotiations with them, or preferably commencing without prejudice discussions if those are a genuine attempt to resolve an existing dispute between the parties (see Follow up ). These negotiations or discussions should be made “subject to contract” (see Follow up ) and are held with a view to then entering into a written settlement agreement with them (see Follow up ). Under this agreement, the executive essentially agrees to compromise those claims that are specified in it in return for the severance package .
Pro advice. If the executive is a director, under ss.215-222 Companies Act 2006 shareholder approval is required for most severance payments to directors. This includes payments for loss of office as a director of the company. Shareholder approval isn’t, however, required for “payments made in good faith” in discharge of an existing legal obligation, e.g. payments made pursuant to an existing PILON clause, or by way of damages for breach of such an obligation, e.g. damages paid where there is no PILON clause, or by way of settlement or compromise of any claim arising in connection with the termination of employment.
Directors
It’s important to bear in mind the distinction between a director’s office and their employment - the termination of their employment doesn’t automatically affect their position as a director. However, if the executive is a director, their service agreement will often state that in the event their employment is terminated they are required to resign as a director. Usually, a departing executive will be willing to resign any directorships once a suitable severance package has been agreed. Written resignation as a director can therefore be obtained as a condition of the settlement agreement.
Pro advice. There are procedures that can be followed to remove a director from office by ordinary resolution of the members in a general meeting, but these take longer than simply obtaining a resignation (as 28 days’ notice of the meeting will usually have to be given).
Transfer of shares
If the executive has shares in the business, you may want to obtain a transfer of those shares. You’ll need to check the company’s articles of association and any shareholders’ agreement to see if they contain provisions requiring a shareholder to transfer or sell back their shares to the company on termination and if they outline how the transfer value of the shares is to be calculated. The mechanism for determining the transfer value may depend on whether the executive is being treated as a “good leaver” or a “bad leaver” .
Pro advice. If there’s no shareholders’ agreement and the articles don’t adequately deal with shares on employment termination, transferring the shares and determining their value becomes a matter of negotiation. This can be covered in the settlement agreement.
Protecting business interests
If there are no post-termination restrictive covenants in the service agreement or employment contract, you can add new covenants to the settlement agreement, provided you give the executive some consideration for them. This could be a nominal sum of around £200, but they may want more.
Pro advice. If you require the executive to leave immediately with pay in lieu, and there’s no contractual PILON clause, as mentioned above you’ll be in breach of contract, and this then invalidates any restrictive covenants in the contract. Where you wish to rely on restrictive covenants in this scenario, it may be necessary to terminate their employment on full notice. Alternatively, if there’s a garden leave clause (see Follow up ), you could place the executive on garden leave in the meantime, restate the restrictive covenants afresh in the settlement agreement and then pay the executive in lieu for the remainder of their notice period once the settlement agreement has been signed off.
Other benefits
Don’t forget to check the contract to establish if the executive has a right to any other benefits beyond those generally available to other staff, e.g. a contractual enhanced redundancy payment scheme.
Director’s service agreement
Pay in lieu of notice clause
Settlement agreement meeting proposal letter
Letter to accompany settlement agreement
Settlement agreement
Garden leave clause
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