28 September 2023
Businesses make share plan awards available to their employees as a key strategy in retaining people in the business. Leaver provisions are a key part of any share plan; if employees could always keep their share awards with no consequences arising from leaving employment, then the retention impact of a share plan would be minimal. But how should these be structured, and how should a company deal with the situation when they do have a leaver?
What happens when an employee leaves the business?
When an employee leaves, there are three main possibilities on what might happen to their share awards:
- they could lapse, either in full or in part, resulting in the employee losing their award and receiving no value for it;
- they could become immediately exercisable (in the case of options) or immediately vest (in the case of other types of awards). This could apply to the whole award, or just a part of it; and
- they could remain in existence, continuing to be subject to any performance conditions (for example they might have to be held until there is a future sale of the business).
For those employees entitled to retain some or all their award; commercial and tax factors will impact whether, for example, they are required to exercise their option within a certain period or hold it until a future date. For some tax-advantaged awards such as EMI, an employee who leaves the business needs to exercise their option within a certain period to ensure that the full tax benefits are retained. Although some companies will prefer an employee who is retaining their award to remain only as an option holder rather than becoming a shareholder at that point.
Does it matter why an employee leaves?
In many share plans, the treatment of a leaver will depend on the reason for the termination of their employment. Plans often distinguish between “good leavers” who might be treated generously, and 'bad leavers' who might lose their award entirely or be treated less favourably.
What constitutes a good and a bad leaver varies greatly between different companies and different share plans. In some cases, the definition of a good leaver will be very narrow, perhaps just encompassing death and being unable to work due to serious illness, injury or disability. In other share plans, the definition will be significantly wider, including reasons such as retirement and redundancy.
One of the most significant decisions is how to treat an employee who simply hands in their notice to take an alternative job with a different company. In the majority of UK share plans this would be treated as being a bad leaver. However, some share plans will allow such an individual to keep some element of their entitlement, often based on a vesting schedule. For example, 25% of an award might vest a year after it is granted, and the remaining 75% might vest over the next three years, with the award becoming fully vested after four years.
In some types of tax-advantaged plans, the reason for leaving employment can have an impact on the tax treatment of the award.
Should our leaver provisions be generous or strict?
There is no single right answer to this question. It depends in part on what the purpose of the share plan is, and also on what the expectations and demands of a particular company’s workforce are in order for a share plan to be motivating and attractive.
Share plans in private companies are often designed to encourage employees to stay with the business until a sale or IPO is achieved. In that case, a person who leaves the business before that event can often expect to lose their award entirely unless their reason for leaving falls within a very narrow category of a good leaver.
In some industries, particularly the technology sector which is heavily influenced by US practice, employees might expect more generous treatment and demand that they can keep their vested awards unless they leave due to a narrow category of bad leaver reasons such as misconduct.
From an employee’s perspective, ‘too generous’ leaver provisions may not have the intended impact of encouraging them to remain with the business. ‘Too strict’ provisions may be demotivating and even cause an employee to reject an offer of employment or leave the business to join a competitor with a more attractive share plan.
Can we have discretion on how to treat leavers?
Sometimes, the Board or Remuneration Committee of a company might have partial or complete discretion on what happens to a share award. Discretion can be useful, particularly for dealing with unusual or unexpected circumstances, but caution should be exercised for two main reasons:
- having entirely discretionary leaver provisions may undermine the incentivising impact a share plan should be designed to have. Employees may feel uncomfortable if they don’t have certainty on how they would be treated if, for example, they had to leave the business due serious illness; and
- for UK share plans operating under HMRC’s tax-advantaged share plan rules (for example EMI, CSOP, SIP or SAYE), the use of discretion can in some circumstances cause an award to lose its tax-advantaged status. This is not always the case, but expert advice should be taken when drafting the rules at the outset and any time a company is considering using a discretion that it has under those rules.
Can an employee claim compensation for a loss of their share award?
Share plans will almost invariably contain a provision stating that no compensation will be payable for the loss of any rights under a share plan on termination of employment. Successful claims for the loss of share awards are therefore rare. However, in some circumstances where there has been an unfair dismissal, or a breach of contract caused by the way in which the employer exercised its discretion to permit the exercise of a share option after termination, an employee could successfully bring a claim. While there is a cap on the compensation award for unfair dismissal, there is no such cap on damages for breach of contract. Expert advice from an employment lawyer should be sought where there are any concerns in this area.
Do we need to take action when someone leaves?
The first port of call is always to consult the rules of your share plan.
In some cases, particularly where a share award takes the form of a share option, the award may lapse automatically when an individual leaves employment and no action may be required by the company. In other situations, the company needs to take particular steps. This is almost always the case where the share award involves the employee actually holding shares, as if they are to forfeit their shares this will usually require some particular legal steps.
Acting quickly can sometimes be critical. For example, the terms of a share option might state that the award will lapse 90 days after termination of employment unless the board determine that it will not lapse. If the decision is not taken within that specified period, and any required steps completed, then any later decision to allow the individual to keep their award may be too late to protect any tax-advantaged status of the option.
If you would like more advice and guidance on share plans, please contact Martin Cooper or Charlie Barnes.