Refusal to pay resigning employee fair market value for shares not unfair
An employer had not treated an employee unfairly when it refused to pay her the fair market value for her shares after she resigned and became a ‘bad leaver’. The employee failed to get the agreement set aside. As a result she only received the price she paid of £1 per share.
Good leaver and bad leaver terms
‘Good leaver’ and ‘bad leaver’ terms are often included in employee share sale or ‘earnout’ agreements.
Share sale agreements in the employment context are relatively straightforward. They usually relate to a senior employee and shareholder selling their stake in the company they work for. Generally, employees receive cash at the time of sale but sometimes they receive payment at a later date, providing they do not become a bad leaver.
An earnout agreement entitles an employee to extra payments in the future if the business achieves certain financial targets. These extra payments are awarded in the form of earnout shares which the employee sells back to the company at a later date. Earnout agreements often require employees to stay with the employer for a set period, typically three to five years. If the employee leaves during that period, they will be a bad leaver and will not be entitled to sell the shares back to the company. These terms are designed to retain the employee during the period stipulated.
In share sale and earn out agreements, the definition of a good leaver and a bad leaver will vary.
Mrs Nosworthy’s shares
Mrs Nosworthy was employed by Communication Operations Limited. In 2011, she bought a 2% shareholding. She went on to sell that shareholding when Instinctif Partners (“Instinctif”) acquired Communication Operations Limited under a share sale agreement. She agreed that she would receive a cash payment up front for her shares and additional earnout shares in Instinctif.
The earnout shares would pay out over a three-year period. Mrs Nosworthy would not be entitled to the full market value of her shares if she became a bad leaver during that three-year period. Instead Instinctif would acquire her shares at the price she paid for them of £1 per share. Mrs Nosworthy would become a bad leaver if she resigned.
Mrs Nosworthy resigned and tried to cancel contract
Mrs Nosworthy resigned and so became a bad leaver. Instinctif refused to pay her the full market value of her shares and paid her £134 in total for 134 shares.
She brought a claim in the employment tribunal. She argued that the bad leaver provisions were unenforceable as they amounted to an unconscionable bargain and a penalty.
A party can seek to cancel a contract if it amounts to an ‘unconscionable bargain’. They must show the court they were at a serious disadvantage which the other party ‘exploited in a morally culpable manner’, resulting in the transaction being oppressive.
The employment tribunal disagreed with her and rejected her claim. It decided that the bad leaver provisions did not amount to an unconscionable bargain.
Did the bad leaver provisions amount to a penalty?
If an agreement requires a party who breaches it to pay the other party a specified sum, the courts will not enforce that term if it amounts to a penalty.
Mrs Nosworthy argued that the bad leaver provisions amounted to a penalty because they required her to transfer her shares for limited value. The employment tribunal disagreed. The law on penalties did not apply as Mrs Nosworthy had not breached the agreement by resigning.
Mrs Nosworthy appealed to the Employment Appeal Tribunal (“EAT”).
Mrs Nosworthy appeals but Employment Appeal Tribunal rejects claim
The EAT said that a party wishing to set an agreement aside as an unconscionable bargain must show that:
- They were at a serious disadvantage through ignorance or a lack of legal advice
- The other party sought to exploit that disadvantage in a morally culpable manner and
- The resulting transaction was oppressive
The EAT found there was no evidence that Mrs Nosworthy had been unable to take legal advice when agreeing to the share sale/earnout arrangements. In fact, she had confirmed in the share sale agreement that she had taken legal advice and she agreed the bad leaver provisions were reasonable.
The EAT dismissed Mrs Nosworthy’s argument that the bad leaver provisions were a penalty. It agreed with the employment tribunal’s decision. The rule on penalties only applies where a party has breached the contract. Mrs Nosworthy had not breached the contract by resigning and Instinctif had not alleged that she had. Therefore, the law on penalties did not apply.
Employees offered shares or earnout arrangements should take independent legal advice at the outset. They need to understand what the good and bad leaver rules mean for them, especially where resigning makes them a bad leaver.
There is no standard definition of good and bad leavers, so resigning will not always make the employee a bad leaver.
Nosworthy v Instinctif Partners
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