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