Gannons Solicitors 020 7438 1060
London solicitors specialising in the law relating to employment, partnerships/LLPs and company commercial
There are a number of issues to consider when establishing whether damages or compensation is payable on the termination of employment of a director or an employee. The payment of damages can stem from rights under the employment contract or director's service agreement or under the shareholders agreement and articles of association. Rights to compensation also arise under UK employment law.
Our commercial employment law solicitors advise employers on how to evaluate the damages or compensation payable on dismissal of an employee or a director. We work equally with directors and employees who face dismissal or have been dismissed to advise them on what amount of damages or compenastion they should seek and their rights and employment law litigation.
Based on our experience of advising on damages and compensation due on termination of employment we have prepared a summary of the key issues to consider.
A key consideration, when deciding how to handle dismissal of a director or an employee, is likely to be cost. The first step for the employer when assessing the likely cost will be an analysis of the employee's contract of employment, director's service agreement, articles of association, shareholders agreement and rules of any employee share plan, option plan or EMI option scheme plus any other surrounding benefits. The employer will need to obtain:
A breach of contract will usually occur when an employee or director is dismissed without notice. Many dismissals are in breach of contract as the employer having decided to dismiss does not require the services of the employee or director and see little point in having him in the office. If the contract of employment or director's service agreement includes a garden leave clause this may be invoked to avoid a breach of contract by requiring the employee or director to remain at home.
Employees and directors, who are wrongfully dismissed, are entitled to claim damages representing the pay and benefits they would have received had they been able to work for their full notice period. In the worst case scenario this could mean payment up to the end of the notice period or, in the case of a fixed-term contract, payment up to the end of a fixed term.
However, employees and directors are required to mitigate their loss by seeking alternative employment, which gives an employer some room to negotiate on the appropriate settlement and offer as compensation in place of damages and to reduce the level of damages that would otherwise be payable. Institutional shareholders will expect boards of listed companies to ensure that full benefit is obtained in relation to the duty to mitigate when dismissing a director.
The difficulty with this approach is that, particularly in the case of senior employees and directors who are being dismissed for poor performance, the prospects of the employee mitigating their loss by securing alternative employment may, in reality, be quite small, giving the employer limited room to negotiate.
When assessing the likely damages, employers will have to take into account the following:
If the dismissal is by reason of poor performance or the employee or director has contributed towards his dismissal the amount of damages due will be reduced. In cases of gross misconduct the employer will be entitled to dismiss without notice and without paying damages or compensation.
The employee or director is likely to argue that the damages should reflect any bonus to which he would have been entitled during the notice period. Where the employee has a contractual right to a bonus, the employee is entitled to a realistic assessment of the position he would have been in if the employer had performed its obligation under the contract.
Care is required on how any discretion in an employee bonus plan is exercised as unfair uses of discretion can be challenged.
This is another area where issues often arise about an employee's entitlement to benefit in damages. Where share options have already vested, the employer may have a discretion to allow the employee to exercise those options in the usual way. In practice, it will be very difficult for an employer to justify a refusal to exercise its discretion in this way.
Another issue arises where the employee has been granted options that would have vested had the relevant period of notice been given. In many cases the service contract will contain a provision providing that the employee is not entitled to compensation on termination of employment for any loss of any rights and benefits under the scheme. Such clauses have been upheld in the past, with the effect that the employee is not entitled to be compensated in damages for benefits that have not vested. However, this would not prevent an employee from claiming compensation for loss of share options in an unfair dismissal claim.
Employee share schemes do vary enormously and the rules of the plan must be checked. There is often a distrinction between entitlement and the reason for dismissal or termination of employment. For example, redundancy is often regarded as a good leaver reason for dismissal and rights to exercise options and receive awards of shares are preserved. Many employers wishing to provide benefits to the employee or director on dismissal will often therefore refer to the termination as being by reason or redundancy.
The tax advantageous status of EMI options will be lost if the EMI option is not exercised within 40 days of ceasing to be employed for any reason. The EMI option legislation does not distinguish between the reason for leaving or the background to the termination of employment or directorship.
Most EMI option plans will include exclusion of liability clauses on termination of employment.
These are potentially significant in calculating breach of contract damages on termination of employment. Particularly where the employee is entitled to benefits under a final salary scheme or some form of unapproved pension scheme. In a money purchase scheme, calculation of the loss on termination of employment is relatively straightforward and will represent the contributions that would have been made by the employer during the notice period (subject to the employee's or director's duty to mitigate).
Calculating damages on termination of employment where the employee or director was a member of a defined benefit scheme is more complicated, and actuarial advice will often be required. Broadly speaking, damages should reflect the difference between the deferred pension to which the employee or director would have been entitled at normal pension age had they been given their notice, and the deferred pension to which they will be entitled at normal pension age having been dismissed in breach.
The rules on taxation relating to pension contributions have changed and income tax relief for the employee or director has been restricted in certain circumstances. You will need a record of pension scheme contributions made over recent years in order to determine if the tax relief will be restricted.
Damages in respect of loss of a company car on termination of employment will also depend on the way in which the benefit is provided. If the employee or director has been provided with a car allowance, they will be entitled to payment of the car allowance they would have received during the notice period as a lump sum, subject to mitigation and a deduction for accelerated receipt. If the employee or director was provided with use of a car through a company scheme, the damages will reflect the cost to the employee of leasing that type of car for the length of the notice period.
It is unclear whether the damages on termination of employment should include an element in relation to the holiday that would have accrued during the notice period. If there is a contractual payment in lieu of notice clause PILON then it should specify how that payment will be calculated. If there is not a contractual payment in lieu of notice clause PILON then the Working Time Regulations 1998 (WTR) only refers to a payment on termination in lieu of unused holiday accrued up to the date of termination, and does not refer to any rights that would have been accrued during the notice period. It is, therefore, arguable that the damages should not include an element in relation to any statutory holiday entitlement that would have accrued during this period. However it is arguable that, if the employee or director is entitled to holidays in excess of their rights under the WTR, then they should be compensated for the holiday that they would have accrued during the notice period.
The employer will need to consider the other benefits to which the employee or director is entitled under his contract, typically things like life insurance, private medical insurance or permanent health insurance. Damages on termination of employment will reflect the cost to the employee of obtaining those benefits during the notice period. Alternatively, in some circumstances it may be possible for an employer to continue to provide those benefits through a group scheme, at least for part of the notice period, or for the employee or director to continue making their own contributions into the scheme at a preferential rate.
It is common to find a pay in lieu of notice clause in an employment contract or director's service agreement, entitling the employer to terminate the employment with immediate effect on payment of a sum in lieu of notice. In cases of gross misconduct the employer would not be required to made a payment in lieu of notice if he is entitled to dismiss without notice.
The pay in lieu of notice clause PILON should specify exactly how the payment will be calculated and, in particular, whether it will include compensation in relation to bonus plans, commission schemes and holidays.
The employment is terminated lawfully, meaning that any restrictive covenants can be enforced (to the extent that they are enforceable as a matter of general law).
The employer has an opportunity to agree when the employment contract or director's service agreement is entered into exactly what elements of remuneration will be taken into account when calculating the payment in lieu of notice. For example, it may be possible to agree that the payment will be calculated solely by reference to the basic salary the employee would have earned during the notice period, excluding bonuses, commissions or other benefits. Alternatively, if benefits other than salary are to be included in the payment in lieu, there is an opportunity to specify exactly how those will be calculated.
For example, it may be possible to agree that a specified lump sum will be paid in respect of benefits such as life cover and private medical insurance.
A properly drafted pay in lieu of notice clause PILON generally means that the amount of the payment in lieu will be easy to quantify and there will be very limited scope for the employee or director to argue about the level of the payment.
It makes the payment tax inefficient from the perspective of both the employer and the employee. As the payment counts as earnings from the employment, it will be taxable in full at the employee's marginal rate. The £30,000 relief to income tax on termination of employment is not available to the extent the payment in lieu of notice is less than £30,000.
If the employee or director has been wrongfully dismissed from employment in addition to damages due under the employment contract or director's service agreement, he may be entitled to compensation under UK employment law. For example, if an employee or director can establish:
additional compensation may be due. Employees and directors have similar duties to mitigate as they do for damages claims. Compensation due for statutory rights will be reduced in cases of gross misconduct or poor performance, etc. In practice therefore many employees and directors are unable to claim additional compensation in respect of statutory rights as the payment of damages under the contract of employment or director's service agreement adequately compensates them for losses arising upon termination of employment.
A key consideration, when deciding how to handle dismissal of a director or an employee, is likely to be cost and an estimation of the likely damages or compensation the employee or director may seek to claim.
The first step for the employer when assessing the likely cost will be an analysis of the employee's contract of employment, director's service agreement, articles of association, shareholders agreement and rules of any employee share plan, option plan or EMI option scheme plus any other surrounding benefits.
The employer will need to consider what benefits are payable during the notice period and which benefits are not. The answer will depend upon the contractual position set out in the employment contract or director's service agreement.
The payment of damages or compensation due on termination of employment can be reduced by the requirement of the employee or director to mitigate his loss arising on termination of employment. If the dismissal is by reason of poor performance or the employee or director has contributed towards his dismissal the amount of damages due will be reduced. In cases of gross misconduct the employer will be entitled to dismiss without notice and without paying damages or compensation.
If the employee or director is a shareholder in a private company it will be necessary to consider the articles of association and shareholders agreement in detail to determine what the position is on shares held by the employee or director upon termination of employment. Damages are seldom due for loss of share rights although if the shares have value this is a cost to be included in the overall calculation of money payable to the employee or director.
Both employers and employees need to consider the position on taxation of termination payments and payments of damages. Careful tax planning is often required.
This paper is designed to provide a summary of the issues addressed. Therefore, it is not intended as a detailed commentary on the relevant law and any comments made should not be acted upon without first taking specific legal advice.
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