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TUPE & share incentive schemes

If you acquire a business as an asset purchase, then, under TUPE 2006, you should offer employees a “substantially equivalent” share incentive scheme.

When hiring staff who enjoy an existing share incentive scheme, there are two scenarios:

  1. The new employee has shares or options in their current employer’s company;
  2. The employer purchases a business, via a share or asset sale,  with employee share or option holders.

New employee has shares or options in their previous employer’s company

In this case, the new employer has no obligation to offer the new employee a share incentive plan. Whatever is offered is a commercial negotiation, involving the employer’s commercial objectives and the employee’s expectations. To negotiate the right plan, consider these fundamental questions:

  • Direct share purchase or share options?
  • How much equity to give away?
  • Is vesting tied to any performance conditions?
  • How will employees obtain value?

Plans appropriate for small private companies are often inappropriate for larger organisations, and vice versa. Good plans contain unique points which affects the implementation.

Business acquisition

A business acquisition can be structured as either:

  • A share sale upon which the employees stay employed with the current employer; or
  • An asset sale where the employer changes.

If the new employer cannot maintain the existing share plan(s), or declines to maintain the plan(s), then the new employer may be liable for compensation. Liability depends on the facts.

Share sale

Many share option plans permit employees to exercise their share options when the group or subsidiary is sold. Employees and shareholders are dealt with in the same way.  The acquirer can choose to implement a new plan, but has no obligation to implement a replacement plan.

If the employees are option holders then under some plans there is provision for the shares under option to be rolled over into the acquirer under a share for share mechanism. We often see share awards in smaller private companies tied to exit and options exercisable upon sale or merger.

Asset sale

Often when a business sale is structured as an asset sale,  the Transfer of Undertakings (Protection of Employment) Regulations 2006, SI 2006/246 (TUPE 2006) applies. Where TUPE 2006 applies, assets and liabilities, such as employees and their rights, are transferred from the old employer to the new on the same terms.

TUPE 2006 has substantial implications for employers in relation to employee incentives. Case law suggests that the new employer might have to offer a replacement arrangement which is ‘substantially equivalent’ to the plan provided by the old employer. Whether a plan is sufficiently equivalent is judged on case-by-case basis.

The new employer, who does not offer a ‘substantially equivalent’ plan, can face breach of contract and unfair dismissal claims. Employers should consider creating their own share incentive plan to reduce this risk.  If employers cannot create a share incentive plan, then compensate the new employees for their loss. Carefully consider

  • The terms of the plan; and
  • The difference in respective value;
  • The market for the shares held by employees.

How to calculate compensation

The calculation depends on the facts, and is different for share and asset sales.  Consider:

Tax-advantaged status

If the transaction results in a loss of tax-advantaged status, then this is a loss to the employee. Many plans include an appropriate disclaimer of liability in the event of loss of approved tax status. Although there is little case law to establish precedence, it is likely that such a disclaimer would be enforceable.

TUPE 2006 and compensation

If a TUPE 2006 transfer results in the loss of a right to participate in a share plan, the employee may have a right to compensation.  The compensation should account for the amount the employee would expect if they cashed out their share plan. TUPE 2006 also requires the transferor and transferee to consult in advance. You should also consider whether the employee will receive benefits under the transfer, that s/he didn’t enjoy pre-transfer.

Share options

If the transaction price per share is less than the option price, claims to compensation are unlikely. The employee can just let the option lapse. The advantage of options is that they are a one-way bet.

Holding shares

If the plan involved purchases shares, and the transaction generates a loss compared with the acquisition price, then the employee will not have a claim to compensation. The employee is the same position as any other shareholder, unless otherwise agreed.

Challenges to the awarded compensation

Employees generally find it difficult to challenge the compensation. There are two common hurdles that prevent claims:

  1. Many plans include clauses disclaiming liability.
  2. Employment tribunals are reluctant to deal with claims over loss of share rights.

The biggest area of dispute arises in private companies over the method of calculating share value. However, the well-advised will have a process for valuation set out in the share documentation (usually the articles or shareholders agreement) designed to avoid disputes.

Three challenges when unpicking share incentives

The main challenge is the plan design. The plan has to take account of how much equity the company is willing to give away and under what conditions. While issuing shares to employees might be preferable to employees, a company might prefer to grant share options and retain greater control over dividends and corporate decision-making—it is a balancing act between incentivising employees and shareholder interests.

Secondly, share valuations. Share valuation is an art, which takes business knowledge and experience to get right.

Thirdly, communication.  Share plans can confuse both employees and the company’s management.   Therefore it is key that employers explain the intended plan in plain English to relevant employees and set out the employment and tax law implications the plan might have for them.
Many plans provide for discretionary decision-making over matters such as ‘good and bad leavers’. The use of discretion is always a potential minefield and an area for dispute. Well-drafted plans can reduce the risk by appropriate provisions concerning the use of discretion.

Gannons advice for those drafting employment contacts that involve share incentives.

Separate employment terms and employee share rights, because:

  • Employment contracts cannot exclude employer’s liability for loss connected with termination of employment.
  • Share plans that include exclusion of liability clauses can be enforceable.

An exclusion of liability clause in a share incentive plan is helpful for an employer when, for example, the employee wants to sue the employer for losses as a result of dismissal. Keeping these separate minimises the risk of claims.

Catherine Gannon is a member of the employee share plan team.  There are many surveys and statistics which show that companies with employee share plans in place out perform those without.  We implement a wide range of solutions for a wide range of business needs.

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