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Significant changes in corporate governance in recent years have led to a material rise in disputes over employee incentives. An employee who has previously benefited from generous stock and other incentives can no longer be comfortable in the knowledge that his vested entitlements are safe.

On the other hand employers seeking to clawback vested incentives or reduced unvested incentives face increasingly complex challenges. For example in 2014 when Tesco discovered a serious revenue recognition issue it sought to withhold certain benefits which were due to be made to departing senior executives, only to decide later on as a result of legal advice that it was unable to do so.

Below we set out four key tips to assist employers in dealing with complex disputes taking into account the various areas of law which are often engaged.

Clawback Provisions

These provisions are often contractual provisions that give employers the discretion to reduce or recoup some or all of an incentive which an employee might otherwise have expected to receive or to retain in circumstances where some act of misconduct has occurred or a state of affairs which have understood to subsist in factors not.

The discretion given to the employer may be unrestricted or may be restricted within certain parameters.

The final decision as to whether or not a discretion is or will be exercised is often following a lengthy process of investigation. It is important that the employer drafts these clawback provisions in a way that it enables the employer to withhold incentives pending the outcome of the company’s investigation.

Exercise of Employer’s Discretion

The exercise of an employer’s discretion is now subject to an increasing number of implied restrictions following recent developments in case law:

  • Irrationality

It is quite a high hurdle for an employee to succeed in claiming that the employer’s exercise of its discretion was irrational. However in a recent case an employee who was dismissed for poor performance was then deprived of his ability to exercise certain stock options by the board’s exercise of its discretion to forfeit those options. The Court of Appeal concluded that the decision was irrational, that no reasonable employer would have made that decision.

  • Trust and Confidence

In the context of the exercise of discretion, this is often a last resort leading to a claim for constructive dismissal.

Penalties

Another consideration is whether the provision in question constitutes an unenforceable penalty.

Normally the clawback provision will operate on a breach of contract but if it is does not the penalty clause doctrine could apply.

A recent Supreme Court decision clarified the issue on penalty clauses and made clear that the test for what constitutes an unenforceable penalty will be whether the clauses are a secondary obligation that imposes a detriment on the contract breaker which is out of all proportion to any legitimate interest of the innocent party in the enforcement of the primary obligation.

Tax issues

The position on tax is complex and many employers simply decide to recover the net sums received after application of tax when applying clawback. In fact careful drafting is required if the employer intends to reserve discretion to seek a clawback on a gross basis.

These types of disputes are increasing in number. The breadth of legal expertise required to deal with them is also increasing. Expertise may stretch across employment, tax, share schemes, pensions, regulatory issues, financial services and public law.

Need Some Advice?

If you have any questions about workplace incentives, call to speak to a specialist employment lawyer using the telephone numbers below. Bray & Bray have three main offices across Leicestershire, feel free to phone or pop in to talk to our solicitors.