Fri 20 Aug 2021

A step-by-step guide for removing senior executives

Innes Clark explains how to avoid the pitfalls associated with senior executive terminations

The dismissal of a senior executive may be both time and commercially sensitive. The need to act swiftly, limit the opportunity for public disputes and manage the message are likely to be the over-riding considerations. While the reason for the dismissal will be relevant to what package the executive may be offered, the fairness of the dismissal may be of lesser concern.

Prepare thoroughly

For employers looking to manage an exit, the old adage ‘failing to prepare is preparing to fail’ is particularly appropriate. Knowing the reason for dismissal, the risks and the likely cost, as well as planning how to manage the process, may require an initial time investment. However, it should mitigate any surprises along the way, maximise negotiating strength and help bring the process to a speedier conclusion.

Identify who has authority to dismiss

The first potential stumbling block with senior executives is who is making the decision to dismiss? Many senior executives will be involved in high-level decisions, so how can this be done without alerting the individual concerned? Is board approval required and, if the individual is a board member, are they entitled to be notified of the meeting to decide the issue? If it is not possible to follow due process in this scenario then the dismissal may be open to challenge further down the line.

That said, very often what will happen in practice is that if board approval is required and the senior executive is a board member, the board (or key members) will be informally sounded out to check that they support the termination. If the senior executive takes issue with the process, the point will be made that the decision has the board’s support and, if necessary, a full process can be carried out. This usually has the desired effect of progressing matters.

Identify the reason for dismissal

While the statutory fairness of a dismissal is often of secondary consideration when terminating a senior executive’s employment, the reason for the dismissal will inform key aspects of the process. For example, when some form of serious misconduct is involved, the negotiating position will be far stronger than when poor performance (without any prior warnings) or a clash of personalities is the issue. Very often with senior executive dismissals, the real reason relates simply to their face not fitting anymore, which may be due to perceived performance issues or differences of opinion over strategic direction.

The reason for dismissal may also be relevant to the executive’s rights on termination under long-term incentive plans (LTIPs), share-option schemes or the company's articles of association. Whether they are a good or bad leaver may significantly affect the value of any termination package and what happens in relation to any shareholding. The employer should consider all these points in advance so that it has a clear understanding of what the position is.

Check the contract 

While companies may be willing to concede an unfair dismissal as part of any settlement, they will want to avoid breaching the contract or service agreement if possible. The contract will usually contain post-termination restrictions which the company will not be able to enforce if it breaches contractual terms. It is therefore important to check the contract to ensure the termination is effected in accordance with any relevant provisions.

This would include checking what notice is due, whether there is a payment in lieu of notice (PILON) clause and/or garden leave clause and the terms of any LTIPs, share options or bonus payments. These matters could affect the strategy for and the timing of the dismissal. Getting the timing wrong could result in the executive qualifying for LTIPs, bonuses or other benefits that the employer might prefer to avoid.

Where the executive is also a company director then consideration should be given to how to facilitate their removal as a director. Usually, the contract of employment will require resignation as a director on termination of employment and the settlement agreement will then set out the terms that apply. It is important to bear in mind that as long as the executive remains a director, they will be entitled to attend board meetings and access papers.

In many cases, it will not just be the contract that sets out the benefits that a senior executive is entitled to on termination of employment. Other relevant documentation could include the company's articles of association, shareholder agreements, LTIP documentation and bonus scheme rules.

There may be additional post-termination restrictions in one or more of these documents, which may be easier to enforce than those in the employment contract. Equally, if there are no restrictive covenants in place, it may be possible to include them in the terms of any settlement agreement.

The relevant documentation will also set out what effect the termination of employment has on any shareholding or share options. This may have a significant impact on the value of any settlement being offered and how the matter is dealt with.

Calculate the package

In broad terms, quantification of the package to be offered will reflect the senior executive's basic entitlements on termination, the likely value of any potential claims plus the value to the business of a swift and quiet exit.

Basic entitlements 

Quantification of the basic entitlement means checking current salary and benefits, which may well have changed since the executive entered into the contract of employment. Ensuring the information used to calculate the package is up to date seems obvious but it is easy to overlook this when under time pressure. Not only can this result in an incorrect calculation but it also looks amateurish at the outset of a negotiation.

Potential claims

The most likely claim on termination (assuming the necessary length of service) is unfair dismissal. The executive may also claim wrongful dismissal if notice has not been given. It is important, however, to consider whether:

  • the executive can argue that there has been some form of unlawful discrimination, in which case there is no cap on the amount that an employment tribunal can award;
  • the executive is likely to claim automatically unfair dismissal for blowing the whistle or raising certain health and safety issues, where, again, there is no cap on the compensation; and
  • the reason for dismissal is redundancy, in which case statutory redundancy pay will need to be calculated and there may also be an entitlement to a more valuable enhanced redundancy payment.

Financial issues 

Where the contract allows for it, the business can make a PILON on a phased basis over what would have been the notice period and deduct any income the executive receives from new employment from the instalments. This may be more palatable from a corporate governance perspective than paying out one lump sum when the executive is likely to obtain alternative employment quickly.

It is important to understand what tax will be payable on the package. Contractual PILONs and post-employment notice pay (PENP) are subject to both income tax and employer and employee National Insurance contributions. Only the first £30,000 of any ex-gratia payment is tax free (subject to any PENP).

Negotiation is to be expected so, having quantified the claim, the business will often hold something back in reserve. It may also be possible to structure the payment more advantageously, for example by paying some of the settlement sum directly into the executive’s pension. However, this will depend on the rules of the pension scheme and the available annual or lifetime allowances.

Non Financial aspects 

The value of a package is not necessarily just financial. It may include the option of transferring ownership of equipment such as phones, computers or a company car. It may also be possible to continue some benefits such as medical insurance post termination – perhaps until the business renews the policy – and, if so, this should be checked and details provided.

While the increasing prevalence of purely factual references means they now have less value in a negotiation, it may be that some additional wording can be agreed. Any agreed reference should, however, comply in full with any regulatory requirements, where applicable.

Senior executives are also likely to want to agree an announcement on their departure, for use both internally and externally, along with the arrangements for making any such announcement. How the message is delivered is likely to be important to both the employer and the executive, as both will want to avoid reputational damage via a public airing of the issues that have led to the dismissal.

Finally, the business should consider offering outplacement coaching to assist the senior executive in their search for a new role elsewhere.

Draw up the settlement agreement 

Once the business has identified the full package to offer,  it can then draw up a settlement agreement. It is essential to specify the claims that are subject to the agreement, otherwise they may not be validly waived. The agreement will usually also provide for a contribution to the legal fees the executive will incur taking advice on the agreement. Obviously, the more negotiation that is required, the higher those fees will be. However, it is not incumbent on the employer to cover the whole cost and it may well take the view to cap the legal fee contribution on the basis that it does not want to pay for the executive to negotiate against it.

Implement the strategy 

As well as deciding on the proposed terms, the employer will need to decide how to handle the dismissal. It will be relatively rare for a senior executive to be allowed to work out their notice period. Decisions will require to be made about how to make the initial approach to the executive, while staying within the limitations of the terms of the employment contract. Can an initial discussion be had with a view to agreeing terms before termination? Is there a need to terminate immediately and then negotiate? Or can the employer give notice with the executive going on garden leave while negotiations take place? It will all depend on the circumstances.

Where employment is terminated immediately under a PILON, it is essential to make this clear to the employee and to implement the terms of the PILON properly. The business may be able to reduce the costs involved, for example by terminating employment before the executive becomes eligible for a valuable bonus, LTIP payment or share options. Any failure to operate the PILON properly could significantly increase the costs associated with the termination.

It is important to consider whether discussions will be protected under s111A of the Employment Rights Act 1996 or if they will be ‘without prejudice’. There are limitations to both these options. The s111A protection only applies to unfair dismissal claims, which may not be a primary concern. Meanwhile, a conversation is only without prejudice when there is a genuine pre-existing dispute between the parties. It will very often be the case that no such dispute exists when discussions around termination begin and it is important to remember that simply marking correspondence as without prejudice will not make it so.

Correspondence setting out the terms of a termination package should be clearly marked as ‘subject to contract’, as should the settlement agreement itself. This will prevent individual points becoming binding obligations until the parties have agreed the whole package and signed the settlement agreement.

It will assist everyone involved if the business correctly and clearly sets out what the senior executive’s basic entitlements are on termination from the outset. This could include providing additional documents such as share option schemes, confidentiality agreements, articles of association or shareholder agreements so the executive (or their adviser) can quickly and easily satisfy themselves as to what those entitlements are.

Considerations that apply in specific sectors

There cannot be a one-size-fits-all approach to senior executive terminations. Certain sectors will have specific considerations. For example, financial services firms may need to notify the Financial Conduct Authority of the termination. If the company is listed then it will be obliged to notify a Regulatory Information Service of the removal of a director.

Shareholder approval is required under the Companies Act 2006 for certain payments made for loss of office to directors. However, in many cases, the payments made under a settlement agreement to a senior executive who is also a director will fall under an exception which allows payments to be made without approval. This is permitted when the payments are made in good faith to discharge existing legal obligations and by way of settlement or compromise of any claim arising in connection with the termination of a person's office or employment.

In the public sector, although the UK regulations capping public sector exit payments were revoked in February 2021, a cap remains in place for devolved public bodies in Scotland. The application of the cap is set out in the Scottish Public Sector Finance Manual. Public sector employers must act within their statutory powers, be able to justify the level of any payment and ensure it is not excessive, as it could be challenged. Civil service organisations must follow Cabinet Office guidance which provides that they should only make payments over and above statutory or contractual entitlements in very rare circumstances.

Act with clarity and sensitivity 

In practice, the preferable option when dismissing a senior executive is usually to try to reach an amicable settlement. Proper preparation will make that process a great deal more straightforward. While some executives may drag their feet during negotiations if they think it is to their benefit, often delays are caused because of a lack of clarity around the contractual terms or the package that is being offered.

Ensuring clarity of communication is something over which the business will have a significant degree of control. The early provision of supporting documents, such as those governing how shares, share options and pensions will be dealt with, can limit the need for the executive's advisers to seek out more information. Senior managers or the company board can agree the parameters for negotiation in advance, minimising the need to seek further instruction as the process continues. All of these elements can help streamline the process. Good planning will also reduce the likelihood of nasty surprises and limit potential disruption to the business.

The final tip is the need to handle the process with sensitivity. The fact that the individual is a senior executive is evidence that they have a successful career behind them. This may be the first time they have faced a situation which calls their abilities into question and emotions may well run high. Tactful management of the individual will often provide the best chance for an amicable conclusion.

This article originally appeared in the June 2021 edition of the Employment Law Journal.

Make an Enquiry

From our offices we serve the whole of Scotland, as well as clients around the world with interests in Scotland. Please complete the form below, and a member of our team will be in touch shortly.

Morton Fraser MacRoberts LLP will use the information you provide to contact you about your inquiry. The information is confidential. For more information on our privacy practices please see our Privacy Notice