Surprisingly given the commercial significance good and bad leaver clauses are not automatically included in the standard table A company articles adopted on incorporation.
Good and bad leaver clauses
Many companies amend their standard articles to incorporate compulsory transfer provisions. They often impose different rules depending upon whether the leaver is deemed a “good leaver” or a “bad leaver”.
Company and commercial is a core area of practice for us. We can help you by ensuring you have the right clarity on good or bad shareholder leavers. We also very regularly deal with disputes relating to a bad shareholder leaver.
Why are good leaver and bad leaver clauses important?
Good and bad leaver provisions are important as they preserve value for the remaining shareholders by forcing a good or bad leaver to dispose of shares. Typically good and bad leaver clauses are attached to shares held by directors or employees.
The importance is illustrated by the problem faced without a good and bad leaver clause when typically employee or director shareholders move on and stop contributing to the company. Without a good and bad leaver clause they will still own their shares and are not compelled to transfer them and/or the shares retain the same value as all other shares.
Good and bad leaver clauses are only included if the articles are specifically amended to include the clause. In practice the clauses are designed to fit to commercial needs as we explain.
The concept of a bad leaver is intended to cover situations, often where the shareholder is also an employee, where he or she is no longer employed due to circumstances which have damaged the company or the shareholders shares were obtained on advantageous terms based on an agreed future contribution to the company which has not been fulfilled.
To protect shareholders many companies change the company articles and/or have good leaver/bad leaver clauses in a shareholders agreement.
What to include in good or bad leaver clauses?
There are no restrictions on how good and bad leaver clauses are drafted. Typical guidelines on drafting include:
- What constitutes a bad leaver? – usually directors or employees who have been dismissed for fraud or gross misconduct, fail to meet performance targets or voluntarily resign in circumstances were they are not a good leaver.
- Compulsory transfer of shares – the implications of being a bad leaver usually include being forced to transfer shares without being paid for them or at a reduced value.
- What constitutes a good leaver? – usually directors or employees who cease to be employed for good reasons such as redundancy, ill health, resignation in circumstances which do not make them a bad leaver.
- How shares will be valued – The distinction between good and bad leavers is usually centred on the value the leaver receives for the shares s/he muist transfer on exit. There are many ways of valuing leaver shares. The mechanism does not need to be set out in the articles but clarity in the shareholder agreement or company articles on the valuation mechanism will reduce the scope for dispute.
- What is the trigger point for good or bad leaver clauses to apply? – usually this is where the employee shareholder ceases to be employed. This provisions in the articles for good and bad leavers need to dovetail with employment contracts.
- Dispute resolution – auditors, accountants and/or specialist share valuation experts can be asked to determine the value of shares in the absence of agreement between the directors and the leaving shareholder. Valuation of shares in a private company where there is no sale of the entire company on the agenda is inherently difficult and speculative. Interestingly there is no requirement to have an independent valuation.
What happens to the shares where a leaver has to sell?
Good and bad leaver clauses work by setting out in the articles the mechanism for forcing the sale of the good or bad leaver’s shares. The articles should include guidelines on who buys the shares and who gets the right of first refusal. You also need to deal with what happens if no shareholder wants to acquire the leaver’s shares. In practice there are choices to consider.
In the right circumstances the good and bad leaver clause can be made to work by permitting the company to buy back and cancel the shares.
Practical implications where shares are transferred
There is compliance connected with the forced sale of good and bad leaver shares.
- the transfer of shares will need to be reported at Companies House.
- for larger shareholdings a PSC statement may be needed for the remaining shareholders.
- depending upon the value paid for the shares there can be tax to report and pay.
- for most employees and directors the transfer will need to be reported on the annual employment related securities (ERS) return.
Disputes involving good and bad leaver shares
It is necessary to consider the provisions under the employment agreement and the articles. Claims under the employment agreement are separate to claims under the articles. The good and bad leaver position will differ under the employment agreement, articles and shareholders agreement and any option agreement.
Can employment claims include loss of share rights due to being a bad leaver?
Employment law claims are ultimately decided in the Employment Tribunal in most cases. Employment Tribunals are reluctant to get involved with disputes arising out of shares or options as they see that as outside of their jurisdiction. Accordingly, it is rare in practice for compensation ordered by an Employment Tribunal to include loss of share rights and/or loss of share option rights.
How do bad leaver clauses impact share options?
The good and bad leaver provisions in option agreements given to employees or directors are important as they usually serve to trigger the lapse of the option if the employee or director ceases to be employed. Once the option lapses the employee or director cannot exercise the option and acquire shares – hence s/he does not become a shareholder.
The terms of lapse can vary between good and bad leavers. The option agreements usually as belt and braces expressly provide that the option cannot be exercised if the option holder is no longer employed. Many option agreements reserve discretion to the directors to permit exercise if a good leaver.
A share option agreement, employment contract, company articles and shareholders agreement all give rise to different rights.
Catherine is an extremely experienced solicitor and deals with all types of corporate and commercial matters and advice and also tax law. She is well known for turning complex problems into solutions, priding herself on always finding a way. In her spare time she runs Gannons!