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Compensation for loss of office and rewards for failure, Severance payment…
Compensation for loss of office and rewards for failure
Most executive directors enter into a service contract with their company that provides for an annual review of their remuneration and a minimum notice period in the event of dismissal
When a company decides to dismiss a director, it will be liable to pay compensation in accordance with the terms of this service agreement
If a contact provides for a six month notice period, the director will be contractually entitled to six months salary on being dismissed subject to any obligations regarding mitigation
Length of service contracts
The length of a directors service contract or notice period will be one of the most important factors determining compensation payable in the event of early termination
CA2006 introduced a legal threshold for directors service contracts which now states that they must not exceed two years duration without shareholder approval
UK Code provides
Notice or contract periods should be one year or less
If it is necessary to offer longer periods to new directors recruited from outside of the company, such periods should reduce to one year or less after the initial period
The remuneration committee should ensure compensation commitments in directors terms of appointment do not reward poor perofrmance
They should be robust in reducing compensation to reflect departing directors obligations to mitigate loss
Obligation to mitigate loss means the a director should look for replacement work. If they find gainful employment, the company's obligation to compensate them may be reduced. In order to facilitate mitigation, compensation payments should not necessarily be paid in a lump sum
In practice, companies often prefer to negotiate a clean break and to take the negative publicity surrounding any termination payments on the chin
Details of any payments made to former directors for loss of office during the financial year must be disclosed in the annual remuneration report, together with an explanation of how each component was calculated and whether any discretion was exercised in respect of the payment. Discretion may be exercised to increase the termination payment beyond what the individual is contractually entitled to, perhaps to encourage the director to sign a gagging clause
The Listing Rules require companies to disclose in the annual report the unexpired term of any service contract for any director proposed for election or re-election at the AGM and if the director does not have a service contract, a statement to that effect
The ABI and PLSA published a joint statement on best practice on executive contracts and severance. The statement was intended to assist boards and remuneration committees in negotiating contracts with senior executives and avoid situation sin which departing executives are rewarded for failure. Nearly all of the recommendations in the statement are now reflected either in the Code or the statutory disclosure regime. If has also been superseded to a certain extent by the Investment Association's Principles of Remuneration
The Code provides that remuneration schemes and policies should enable the use of discretion to override formulaic outcomes. This intended to allow remuneration committees to make certain adjustments to performance related pay in certain circumstances eg where there is an unjustified outcome
Malus and clawback provision
The code provides that remuneration schemes and policies should include provisions that enable the company to recover and/or withheld sums or share awards and specify the circumstances in which it would appropriate to do so
Malus provisions allow the company is specified circumstances to forfeit all or part of a bonus or long term incentive sward before it has vested and been paid
Clawback provisions allow the company to recover sums already paid
The Investment Association's Principles of Remuneration recommend that the circumstances in which performance adjustment and clawback can be implemented should be
Agreed and documented before awards are made
Reviewed by the remuneration committee to ensure that they remain appropriate
Disclosed to sharheodlers
The usual triggers for invoking malus and clawback are gross conduction and mis-statement of results. However, the Principles of Remuneration now encourage companies to broaden these triggers. They call on remuneration committees to establish a more substantial list of specific circumstances in which the malus and clawback provisions could be used and to disclose these circumstances to shareholders. They accept that malus provisions will probably apply to a broader range of circumstances than clawback
The principles also recommend that
Remuneration committees should review the enforcement powers available to them to implement these provisions
Executives should be required to sign forms of acceptance at the time of grant in order to set the expectations for malus and clawback applying to that award and establish how and when they may be applied
Any communication around the payment of bonuses or long-term incentive plans should also be consistent with the malus and clawback provisions
Remuneration committees should develop clear processes for assessing executives against either malus and clawback criteria and how they will exercise discretionary clawback
The directors remuneration policy of a quoted company is required to disclose whether incentive schemes make any provision for the recovery of sums paid or the withholding of the payment of any sum. If these provisions are ever invoked, details should be provided in the annual remuneration report
Severance payment
: Payment to a director on being required to resign or otherwise leave the company