Negotiating an executive severance package

If you need to part company with a director, for the good of the business, it may not be appropriate to follow your disciplinary procedure. Emma Thompson, employment law specialist at Thackray Williams, looks at the issues you should consider, especially if you need to achieve a quick exit with minimal disruption to the business and no publicity.

Reason for the termination

Two of the most common reasons for terminating a director’s contract are poor performance, leading to the board losing confidence in the director, and a personality clash.

You should first decide what the reason is for the exit, as it will have an impact on the claims the executive may have and therefore on the level of compensation you will need to pay. For example, you must consider whether the director has done something that amounts to gross misconduct so that you would be entitled to terminate their employment without notice. If, on the other hand, their role is redundant, they will be entitled to work their notice period or receive a payment in lieu of notice. You also need to consider whether the employee has any potential legal claims, as that will have to be taken into account in the compensation package.

Calculating the compensation

A settlement offer should reflect the potential legal claims the director may have, as well as the commercial advantage of achieving an amicable and quick settlement. Employers do not want to be seen to reward failure so a balancing exercise will have to be carried out. You should also review the director’s service agreement to see what it provides for in the event of termination.

The compensation will include some or all of the following:

• pay for the executive’s notice period;
• contractual benefits during the notice period, including pension contributions;
• compensation for unfair dismissal, discrimination and whistleblowing;
• statutory redundancy pay;
• bonus payments;
• compensation for loss of share options; and
• accrued holiday pay.

Having the conversation

All discussions about the severance package should be conducted on a ‘without prejudice’ basis so that, if the negotiations break down, the employee cannot refer to them in any later litigation. In order for this label to work, the discussion must be a genuine attempt to resolve an existing dispute. Pre-termination negotiations cannot be referred to in an unfair dismissal case unless the employer has behaved improperly. The negotiations should also be ‘subject to contract’ so that the agreement is not binding until it has been signed.

A binding settlement

We would always recommend entering into what is known as a ‘settlement agreement’ with the Director. This is a legally binding agreement under which the employer agrees to pay a certain sum to the director, in return for their agreement not to bring any contractual or statutory employment claims against the company.

As well as terms relating to the payment and the waiving of legal claims, it is normal for the settlement agreement to deal with matters such as:

• the return of company property by the executive;
• the transfer of ownership of company property (such as a car or a computer) to the employee;
• the continuation of any benefits, such as life assurance and medical insurance;
• the restating of restrictive covenants and confidentiality provisions from the executive’s service agreement; and
• the terms of any agreed reference and announcements.

The director must take legal advice on the agreement and it is normal practice for the employer to pay a contribution towards the employee’s legal fees.

Tax treatment

The taxation of termination payments is a complex area. It may be possible for some or all of the compensation to be paid tax free, depending on the circumstances. However, we recommend that you take advice from your accountant to ensure that you deal correctly with the tax and National Insurance contributions payable on the package.

Other requirements

In addition to the areas set out above, you may need to consider doing the following:

• getting shareholder approval for the compensation payment;
• obtaining the executive’s resignation as a director or, if they refuse, removing them as a director;
• requiring the director to transfer any shares held as a nominee; and
• making internal and external announcements about the director’s exit from the business.

Some of the issues that can arise on an executive termination can be anticipated and avoided by having a carefully drafted service agreement.

Please contact Emma for advice if you are considering terminating an executive’s employment or if you would like to check that your service agreements are fit for purpose.