UK: 'bad leaver' provision triggered by resignation was not a penalty

The Employment Appeal Tribunal has ruled that 'Bad Leaver' provisions in Articles of Association requiring forfeiture of shares were not subject to the law on penalty clauses where triggered by an employee voluntarily resigning on notice, as repayment did not arise on a breach of contract. The fact that the employee had separately contracted not to become a 'Bad Leaver' did not bring the penalty rule into play, as the respondent was seeking to enforce the Articles and not relying on the breach of that separate contract.

The employee had been given a small shareholding in her employer immediately prior to its sale to the respondent (which had made it a condition of the sale in order to retain key employees). The respondent acquired the employee's shares in return for deferred earn-out cash, deferred shares in the respondent and loan notes. The respondent's Articles of Association provided that a shareholder who ceased to be employed would be required to transfer their shares and loan notes, with the price determined differently depending on whether the employee was a 'Good Leaver' or 'Bad Leaver'. A 'Good Leaver' was an employee dismissed in circumstances other than gross misconduct; other leavers were 'Bad Leavers', including those who gave resignation with or without notice. In this case, the employee had given notice of resignation so had become a 'Bad Leaver' without breach of her employment contract.

Under the test established by the Supreme Court in Cavendish Square Holding BV v Talal El Makdessi, a clause that takes effect on breach will be unenforceable as a penalty if it is out of all proportion to the innocent party’s legitimate interest in enforcing the counterparty’s obligations under the contract. The employee sought to argue that the penalty rule should apply on the basis that she had signed a separate agreement not to become a Bad Leaver, which she had therefore breached. The EAT rejected this argument: the respondent was not seeking to rely on the breach of the separate agreement but was simply applying the provisions in the Articles.

The EAT also dismissed the argument that the company's remuneration committee had failed to exercise in good faith its discretion whether to reclassify the claimant as a Good Leaver. The Bad Leaver provisions were clear as to the consequences of voluntary resignation, and there were no exceptional circumstances to call into question the tribunal's decision that the company had acted in good faith.

The EAT did not expressly comment on whether the entirety of the Bad Leaver provisions could be viewed as a primary obligation to which the penalty rule would not apply, or whether the penalty rule would still apply where the employee triggered the Bad Leaver provisions by leaving in circumstances involving a breach of her employment contract (by failing to give full contractual notice of her resignation, or if dismissed for gross misconduct). If the latter, the EAT would then have had to consider whether the consequences of being a Bad Leaver were indeed out of all proportion to the company's legitimate interests in ensuring continuity of performance by the target company's key employees after the acquisition.

The EAT also rejected the argument that the provisions should be set aside as an unconscionable bargain. This requires one party to have suffered serious disadvantage (eg, through poverty, ignorance, or lack of advice), whereas here the employee had clearly had access to legal advice and indeed warranted that she had taken professional advice on the share purchase agreement.

Finally, although the employee had been entitled to bring her claim under the employment tribunal's jurisdiction over breaches of a contract ‘connected with employment’, the EAT held that the claim was not in relation to payments in her 'capacity as a worker' and therefore could not be framed as a deduction from wages claim. A claim that the provisions were an unjustified restraint of trade was also rejected, as it had not been raised before the employment tribunal and so could not be heard on appeal. (Nosworthy v Instinctif Partners Ltd)