Are directors’ severance deals reward for failure?

Should boards be given more bargaining power when it comes to the amount of
compensation a poor-performing director can receive in a severance package?

The DTI consultative document, Rewards for Failure: Directors’ remuneration
– contracts, performance and severance has fine aims. But experience over the
years has shown tackling seemingly excessive severance packages for directors
is more difficult than it might seem.

A director’s severance package is, largely, based on what amount of money
they can claim for damages for breach of contract at common law (an unfair
dismissal maximum award of £53,500 is also handy for them, but set against the
kind of payoffs recently reported in the media, it is small fry). So the
severance package is directly correlative to amount of benefits and the length
of notice that a director enjoys in their service contract.

If a company is performing poorly, the argument goes, why should directors
be handsomely rewarded with a payoff equivalent to their full contract? The
problem is that the common law only allows termination without compensation
where there has either been gross misconduct or, exceptionally, gross
negligence. However, it is difficult to establish gross negligence on the part
of a director or on the other hand, to attribute to one individual director the
poor performance of the company as a whole.

Some have argued that just as an employee is able to make a claim against an
employer for breach of trust and confidence in the employment relationship, an
employer should be able to dismiss a director without compensation where
confidence has been lost by the board or shareholders. The problem is that the
law on the contract of employment is homogenous. If you establish that
principle for a director it would also apply to ordinary workers. And who would
welcome a law that allowed employers to get rid of workers on some nebulous
ground of ‘loss of confidence’?

The consultation document raises a combination of difficult issues. Should
there be legislation or further best practice guidance to reduce notice periods
below the industry norm of one year? Reducing the length of the notice period
reduces, pro-rata, the amount of compensation available on dismissal. But the
DTI is between a rock and a hard place. How far can you reduce the notice
entitlement of a director without it having an adverse effect on recruitment?
And would this simply drive up basic remuneration?

There are two further areas where the DTI welcomes comments. The first is
capping the amount of ‘golden parachute payments’. A golden parachute is a
contractual agreement to assess, in advance, the amount of compensation payable
to a dismissed executive. They cannot claim more than this but, conversely, the
payment is not subject to review if they manage to mitigate a loss and obtain a
job elsewhere. There are clear arguments for limiting this type of safety net.

The second is taking into account performance more rigorously in defending
compensation claims. We have described the difficulties in arguing for reduced
compensation in performance cases. But the problem is compounded by the
outdated content of most directors’ service contracts. Unlike the ordinary
worker’s employment contract, they contain fairly scant detail on performance
requirements for the job, performance management, a disciplinary procedure to
deal with cases for poor performance and the ultimate penalty for poor
performance.

Directors’ service contracts will, once the Employment Act 2002 is fully in
force, have to observe minimum disciplinary procedures. One helpful way to give
boards more bargaining power in reducing the amount of compensation payable to
a director is to tighten up performance procedures in directors’ service
contracts.

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