Greg Vincent, Partner in our Corporate and Commercial team at our Wimbledon office discusses the issues with “bad leaver” clauses and the differences and effects of being determined either a good or a bad leaver in the September edition of our Corporate Insights Newsletter. The recent case of Keystone Healthcare Limited and another v Parr looked at the issue of “bad leaver” clauses. The High Court found that a director who had sold his shares to fellow shareholders and set up a competitor company, was in breach of his duties, triggering bad leaver provisions in the company’s shareholders’ agreement. The result was that the other shareholders were able to reduce the price paid for the shares to that which would have paid under the bad leaver provisions. It’s unusual to see leaver provisions litigated and the judgment in Keystone raised some useful points. Below is a summary of some of the key things to bear, in mind when a company is considering the use of leaver provisions within its shareholders agreement and/or articles. What are “leaver” provisions? These provide a mechanism for shares held by a director / employee to be compulsorily transferred to the other shareholders (or back to the company) if such director / employee leaves the business. They typically sit within a broader range of compulsory transfer provisions dealing with issues such as shareholder insolvency or breach. Leaver provisions provide a direct connection between a shareholder’s entitlement to hold shares in a company and his continued participation in the business. They also help to ensure that shareholder interests are aligned with regard to an exit. Good or bad – what’s the difference? How a leaver is treated is typically dependent on whether he is a “good” leaver or a “bad” leaver. A good leaver will be rewarded for the time and effort spent within the business and triggers range from resignation (having served a period of time in the business) to issues such as death, incapacity, redundancy and dismissal without fault by the director / employee. On the other hand, “bad” leaver provisions are typically deployed to retain a shareholder as an employee / director and act to disincentivise bad conduct whilst in office. They achieve this, principally, by permitting the other shareholders to acquire a bad leaver’s shares for an amount that represents a discount (typically the subscription price or nominal value). Bad leavers often include an employee or director shareholder that has committed fraud, gross misconduct or voluntarily resigns before serving a prescribed period of time. What is the effect of being determined a good or bad leaver? These are subject to negotiation and will depend on the shareholder to whom the provisions will apply, the background to the ownership structure and the plans for the business. Whilst bad leaver transfers are typically for less than market value, in contrast, good leaver provision may entitle the leaver to retain his shares and/or a requirement to transfer shares to the other shareholders for market value. Different valuation methods can be agreed in the shareholders’ agreement and/or articles to determine how this operates (which can include a prescriptive valuation metric and/or third party determination). They may also comprise a mix of valuations, meaning that the shareholder must transfer a percentage of his shares for nominal value and keep the balance (or transfer it at market value). This mix is often used if the shareholder has served a proportion of his minimum time with the business. One issue that regularly arises is how the acquisition of the leaver shares will be financed. In addition to including a grace period to enforce the compulsory transfer, delayed payment terms can be used. However, if the company (rather than the shareholders) is entitled to buy back the shares on a leaver event, the company must finance this out of distributable reserves and the payment cannot be deferred (although the shares can be bought back in tranches). Finally, of particular note in the Keystone case was that, whilst the courts are inclined to uphold bad leaver provisions, it is always important to ensure that a compulsory bad leaver provision does not fall foul of being unenforceable as a contractual penalty. We discussed this issue in more detail back in our October 2015 update. How can Morr & Co help? If you have any questions or would like any further information on the content of this article, please do not hesitate to contact our Employment team on 01737 854500 or email info@morrlaw.com and a member of our expert team will get back to you. Disclaimer Although correct at the time of publication, the contents of this newsletter/blog are intended for general information purposes only and shall not be deemed to be, or constitute, legal advice. We cannot accept responsibility for any loss as a result of acts or omissions taken in respect of this article. Please contact us for the latest legal position. Authored by Greg Vincent Partner, Head of Department Message Tags Insights On this page Related Stories Insights Company share buybacks – an overview View more Contact our team today Contact Us
