Leavers’ Clauses: The Good and The Bad

Leavers’ Clauses

The awarding of shares to directors and employees is a good way to incentivise workers and reward loyalty. When shares are issued, it good practice to have all parties sign a shareholders agreement.

The agreement should deal in detail with what happens when a shareholder leaves the company. The remaining shareholders will not want shares owned by someone outside of the business, so leaving provisions should require the leaver to relinquish their holding.

Good leavers and bad leavers

The relevant clauses in the shareholders’ agreement should distinguish between those who leave on good terms and those who do not. So-called good leavers include shareholders who have become incapacitated through illness or injury and those leaving for reasons of retirement and redundancy and the families of any deceased shareholder.

The term bad leavers encompasses everyone else and includes leaving through dismissal, for gross misconduct, leaving before the end of an agreed term, fraud, bankruptcy, breach of the shareholders’ agreement and acting outside of authority. The term early leavers can be used to avoid the negative connotations of the phrase bad leaver.

What the leavers’ clauses should contain

The shareholders’ agreement should clearly define what will be classed as ill health or disability. Likewise, the terms under which someone is held to be a bad or early leaver must be clear and specific. The agreement can allow for some discretion, but this must be applied fairly and logically and not be perverse or irrational.

The main advantage of defining leavers as good or bad is that they can be treated differently. Good leavers can be rewarded for their service with a high share price, usually fair market value, and possibly a bonus. Bad leavers can be penalised by receiving a much lower payment for their shares. This incentivises shareholders to stay for agreed time periods and to work in the company’s best interests.

Be aware however that a discounted share price is classed as a penalty under the law, and a court may be asked to examine whether it is enforceable if it is overly punitive. On the whole, where the agreement was initially freely agreed to by all shareholders and was not imposed on the complaining party, the court is likely to find a bad leaver clause valid and enforceable, provided that it is commercial in nature and not personal.

More sophisticated shareholders’ agreements can include clauses for intermediate leavers. This allows those who have stayed at the firm for a lengthy period of time and made a serious contribution to the company to be treated more leniently than a shareholder who has left very quickly or who has damaged the company in some way, for example by breach of confidentiality or non-compete clauses.

Exit share price calculation

The agreement should set out exactly how the share price is to be determined, in the case of both good and bad leavers. This will include information such as who will value the shares, what formula is to be used in calculating the final price, the date at which the valuation is to be (usually the leaving date), who is eligible or required to buy the shares and the date by which payment for the shares must be made – which can be delayed to allow for raising of necessary funds. Lengthy delays should be avoided, however, as the courts are likely to find these unfair.

Other documents to consider when drafting leavers clauses

Although a shareholders’ agreement does not depend on other legal documents governing the conduct of the business, when drafting it thought should be given to the provisions of all other relevant documents. These include employment contracts, which will provide details of conduct which could lead to dismissal, articles of association, which will include provisions for share ownership and share option agreements.

When a company’s documentation is well-drafted, to the satisfaction of all parties, it will provide a stable and robust framework, allowing the business to grow and benefit all those with a stake in it. Leavers’ clauses will incentivise and motivate shareholders to do their best for the company, while also deterring people from leaving before their agreed time or from breaching the terms of their shareholders’ agreement or contract of employment.

To ensure an agreement is tailored to a specific business, it should be drawn up by a solicitor who is familiar with company law and able to assess exactly what is needed to benefit both the company and its shareholders.

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