If you are starting or have a small business and are in any doubts as to the importance of having leaver provisions in your business documents or as to why a shareholders agreement, articles of association and senior employee contracts are so important, please read on!
What is a bad leaver? Why is it important?
The concept of a bad leaver is linked to potential action, which might be termed selfish, self serving or damaging to the business or the interests of other shareholders. When this happens, by reference to set criteria, it may already have resulted in damage or loss. Bad leaver provisions generally seek to not only create mechanisms to remove the person from the company, at employee, board and shareholder level, but also to penalise the person for their actions. The most usual method for this is to require sale of the individuals shares to the remaining shareholders possibly at a discount.
Bad leaver provisions may reflect the fact that for serious wrongdoing or damage, such as fraud, it may not be possible to adequately pursue other remedies against the wrongdoer.
Typical bad leaver provisions in shareholder agreements
Bad leaver provisions may be included in a shareholders agreement, the company articles of association or senior executive employment contracts or a combination of all 3. Typical examples of actions which would trigger a bad leaver clause may include fraud, dishonesty or gross misconduct but may also include not acting in good faith, conflicts of interest or exceeding authority. On the shareholder level, possibilities may include (there are many options and all should be carefully considered and possibly negotiated as part of the documents) that the bad leaver’s shares could be valued at 50% of their value or at nominal value.
Bad leaver clauses may also be incorporated into employment contracts, where, for example, share option entitlements might be lost or diluted if the employee is in serious breach of the contract. Care is needed in the drafting of such clauses as English law generally does not strongly support the use of penalty clauses in contracts, and any such clause, as a minimum, would need to be proportionate in terms of penalty to the damage to the employer.
Who and what is a good leaver as a shareholder?
Again, each case is different and there is considerable scope for deciding what this term should mean and how it applies – an experienced lawyer will advise and draft appropriate clauses. However, a typical example of a good leaver might be someone who leaves the company for reasons of ill health or because the company makes him or her redundant. This may apply either at shareholder or employee level. As regards shareholders, the concept of sweat equity often comes into play – this relates to the amount of time and “sweat” a shareholder has put into the business so that an individual who has remained as a shareholder for a designated period of time and/or contributed in some way to the business growth may be entitled to retain shares if leaving as an employee or may be required to sell them back to the company, but the sale price be a genuine reflection of the commercial value of the shares.
Intermediate leaver shareholders
Some shareholder agreements or contracts of employment may even define intermediate leavers – those that do not fall into either category above and where there may be other stipulations as to entitlements and circumstances of departure and/or entitlements and/or mechanism for what happens to the individuals shareholdings, if any.
Recent case example of bad leaver provisions in action
I summarise below the scenario and important points as I see them from this case (Moxon v Litchfield & others), but you may wish to read it fully, so it can be found here.
The facts of this case were that the claimant, one of 3 shareholders in a successful business, was compelled, under bad leaver provisions, to sell his shares to the other shareholders at a substantial discount. The sum involved was significant bearing in mind the case went to the High Court.
The other shareholders claimed in their defence that the claimant was guilty of gross misconduct and had acted in bad faith for his own benefit. He in turn alleged that they had sought, as majority shareholders, to manipulate the situation to lever him out of the company at a discount. The claimant also argued that the court should take into account equitable arguments and that the company was run as a quasi partnership based on personal relationships, trust and confidence which should override the contractual agreements established between the shareholders.
There were a number of agreements involving the parties including :-
- A Shareholders’ Agreement which was varied by deeds of variation
- Articles of Association and revised Articles;
- Service Agreements between the Company and the Claimants and other shareholders also
Important clauses in the various agreements and corporate documents included a service contract clause requiring that executives must not do anything likely to result in damage to the business or bring it into disrepute or which is prejudicial to it.
Having clear provisions in shareholder contracts is essential – in the absence of such provisions, an individual, even one who may be acting selfishly or recklessly as regards his or her fellow shareholders or as an employee, may seek to argue that equitable principles should protect him or her. even if such are unfounded based on the actions and evidence, the prospects of a case being litigated, involving significant costs and stress, where the documents are clear, will be minimised. Consequently, it is vital to consider good and bad leaver issues in shareholder agreements and other documents.
Get in touch with me to discuss how I can help with your business documents and/or for advice on any issues arising relating to good or bad leavers.
Haven't found what you need yet?
Why not search the whole site?