Amidst employment terminations, parties need to understand the impact on equity interests.
Share incentives act as a retention tool and create a pain point to deter attrition. The plan rules prescribe what happens when the employment ends.
What constitutes a 'good' or 'bad' leaver varies. Generally, a 'good' leaver is the exception i.e. involuntary departures by reason of death, serious illness, injury or disability. Sometimes this extends to also cover retirement and redundancy. 'Bad' leaver circumstances range from termination for misconduct to voluntary resignation. A 'good' leaver at departure might subsequently become a 'bad' leaver, due to material breaches of post-termination restrictive covenants.
Leaver treatment under an option plan only applies until the option is exercised. A private company should also ensure compulsory transfer terms for its employee shareholders are in the articles of association.
Boards may have discretion to treat a leaver as 'good' for 'any other reason' but should exercise this power cautiously as:
- this might cause a tax-advantaged award to lose its tax-advantaged status;
- this can be problematic for managing dilution and option pool headroom; and
- managing the employment-related securities ('ERS') tax risk for good leavers will be troublesome in a future corporate event transaction. (An ERS tax charge, including employer NIC and the need to operate payroll withholding, can apply for up to seven years post termination of employment.)
A pricing distinction usually means 'good' leavers receive higher value than others. A 'bad' leaver might suffer financial loss, especially if they subscribed for part-paid shares and must fund an owed subscription price before a compulsory transfer of shares for nominal value.
There's no obligation for a compulsory transfer to be effected in a tax-efficient manner. A company buy-back of shares at a gain will usually result in an income tax charge for a good leaver, as opposed to capital treatment where shares are sold to an employee benefit trust.
Ideally, advice is pre-emptive, before resigning and prior to commencing separation from service process. The timing of notice serving and the reasons for termination may impact how much of an award is vested or unvested and also the 'naughty' or 'nice' leaver status.
For further information contact Liz Hunter.