Shareholder leaver provisions:

Leaver Clauses, which are to be found in either bespoke articles of a company or in a shareholders agreement provide a mechanism which covers circumstances where an employee (usually a senior manager or director of a company) who is also a shareholder, subsequently leaves the employment of the company. Leaver clauses are an extremely useful tool in compelling the departing employee to transfer their shares back to the company (or other shareholders) at a particular value.

There are generally two types of ‘leaver’, with potentially substantial differences in share value:

  • Good Leaver – typically someone who has died, retired at retirement age or left due to disability or bad health.  A good leaver may receive market value for their shares, with no discount for minority shareholding.
  • Bad Leaver – typically someone who is summarily dismissed for gross misconduct or dishonesty or has breached a restrictive covenant, but often identified as anyone who is not deemed a ‘good leaver’. A bad leaver will receive a heavily discounted value for their shares e.g. the lower of nominal or market value.

Enforceability of bad leaver provisions:

There is a continuing question mark over the enforceability of bad leaver provisions. This is because they can be considered a penalty clause and, therefore, unenforceable. A penalty clause is out of all proportion to the legitimate interests of the innocent party and may be considered oppressive and/or unconscionable. Certainly, the differences in value between good and bad leavers will generally always merit a serious consideration of launching a challenge for the designated bad leaver.

A recent Scottish case, Gray & Others, Re Braid Group (Holdings) Limited [2016] CSIH 68, which could be persuasive on the English and Welsh courts looked at this issue. Mr Gray had participated in bribery offences which involved the company. This conduct made him a “bad leaver”. The bad leaver provisions provided that Mr Gray would only be paid the original subscription price for his shares (circa £2.4million) rather than the later market value at departure (worth £20.6million).  Mr Gray argued that this provision was an unenforceable penalty clause and the court should not rely on it when valuing the disposal of his shares for the unfair prejudice award.

The court considered the test set out in Cavendish Square Holding BV v Talal El Makdessi [2015] UKSC 67 which says that it will be a penalty clause if two conditions are met:

1.       It must be a secondary obligation, activated by breach of another obligation, and not a primary obligation that kicks in only in specified circumstances. A primary obligation cannot be a penalty.

2.       It does not protect a legitimate interest, or it protects a legitimate interest but its effect is exorbitant or unconscionable (i.e. not proportionate).

The court found that the bad leaver provision was a secondary obligation but it was not exorbitant or unconscionable, despite the £18million reduction in payment to Mr Gray, and therefore it was enforceable.

It is important to note that the court emphasised the need for parties to be able to freely contract on terms they wish and that the harshness of the provision should be judged at the date it was entered into and not by any disparity between market and nominal value at the date of the employee’s departure.

The importance of this Scottish case is that the court will still scrutinise bad leaver provisions and, therefore, care should be taken when drafting these provisions to ensure that they are not classed as a penalty clause.