Equity offers have increasingly become a common strategy to attract and retain talented employees in companies.

If you are a founder of a start-up who is currently negotiating with investors or a SME involved in an intense competition for engaging top-notch executives, you cannot underestimate the crucial importance to the crafting of 'good leaver / bad leaver' provisions in a company’s articles of association or any shareholders’ agreement which set out the terms of these equity offers.

Last November it was announced that NatWest bank abandoned circa. £7.6 million in potential pay-outs to their former chief executive after she resigned by mutual agreement following the fallout from the de-banking row. It was reported that the bank deemed their former boss, Dame Alison Rose, not a good leaver under the relevant good/bad leaver provisions.

WHAT ARE “GOOD LEAVER” AND “BAD LEAVER” PROVISIONS?

Good and bad leaver provisions serve as mechanisms designed to manage the departure of shareholders. Whether a person is a good or bad leaver will depend on the circumstances in which they leave the company or the group of companies. They can be less commonly found in articles of association, but can typically be found within shareholder agreements.

• Good Leaver: This often involves a person leaving due to reasons beyond their contract, such as redundancy or incapacitation. Another common example is someone retiring or leaving employment after a pre-agreed time. A good leaver can generally sell their shares at market value and may be entitled to benefits as if they were still a member of that company.
• Bad Leaver: Examples include dismissal for gross misconduct, breaching the shareholder agreements or committing fraud within the company. A bad leaver may be limited to selling their shares at the lower end of their market value and their issue price or, less commonly, nominal value.

Determining the sale price is contingent on the ongoing discussions between the parties on what is determined to be a bad leaver and may vary, resulting in the inclusion of additional categories such as ‘Intermediate’ or ‘Very Bad’ leavers. This middle ground could be important to consider. Having such a rigid black and white policy can be unattractive to potential employees.

Good and bad leaver provisions are often subject to negotiations due to the contentious nature of discussions defining what constitutes a good or bad leaver. In recent years, it is noted that there have been several challenges to compulsory transfers related to bad leavers provisions on the grounds that they are penalty clauses and therefore unenforceable. This complexity requires a good understanding and knowledge of legal issues and leads to detailed drafting skills to ensure they are enforceable and suit the parties’ needs and expectations.  

WHY ARE GOOD AND BAD LEAVER PROVSIONS IMPORTANT?

When considering company growth, continually offering increased pay may not be a feasible or attractive way to attract or retain talent. Leaver clauses will be keenly negotiated. Implementing bad or good leaver provisions allows your company to grow by offering shares to employees with certain conditions. This can be favourable for both employers and employees for the following reasons:

• Incentivise shareholders to work hard by offering a share in your company’s growth when leaving and cashing in.
• Deter crucial shareholders from leaving before an agreed-upon date or engaging in misconduct that could harm the business.
• Protecting your company’s interests. Examples of leaver clauses that protect the company’s interests are restricting employees from starting a competing business, keeping confidential information confidential and non-solicitation clauses.

WHAT TO CONSIDER WHEN DRAFTING GOOD AND BAD LEAVER PROVISIONS

1. Company Law: In the absence of explicit provisions in a company’s articles of association or shareholder agreement, a company cannot enforce the transfer of shares from a shareholder. Even if a shareholder acts against the company’s interests, they can retain their shares. For good or bad leaver clauses to be operative, your company’s internal rules must mandate shareholders to transfer shares back to the company or other shareholders based on predefined conditions.
2. Circumstances: A company needs to determine the circumstances in which a leaver may be determined a good leaver or a bad leaver. The flexibility allowed via good and bad leaver clauses allow companies to tailor leaver provisions to those most useful for keeping key talent on board, whilst ensuring bad leavers forfeit their equity. However, companies need to ensure bad leaver clauses are not too draconian and off-putting to employees. Balance would need to be found between protecting the company’s interests and at the same time, allows employees to move on to new ventures and opportunities.
3. Vesting Schedules: When a leaver receives their equity is also a key consideration. By elongating the vesting schedule, your company can ensure employees are invested in the long-term success of the company by incentivising them to grow the company.

Leaver clauses can be controversial and sometimes resisted. These clauses need to be airtight to avoid them being argued to be unfair or legally unenforceable. Nevertheless, they are important in protecting business interests.