Enforceability of Bad Leaver Provisions
Friday 31st May 2019
In the case of Nosworthy v Instinctif Partners Ltd, the EAT considered if ‘bad leaver’ provisions that required an employee to forfeit shares and loan notes if she resigned could be set aside for being unconscionable.
Bad Leaver provisions are common in shareholder agreements, employee share schemes and a company’s articles of association. They are a tool used to deter important shareholders from leaving the business and will typically provide for less favourable terms being received on exit should the shareholder depart before a specified time or under circumstances such as dismissal for gross misconduct. Bad leaver provisions need to be considered when employees subject to such terms leave the business.
Contractual terms found to have been made as a result of an ‘unconscionable bargain’ can be rendered unenforceable. The test to establish if an an unconscionable bargain has occurred has three requirements:
- one party must have been at a serious disadvantage, (such as through lack of advice);
- the other party must have exploited that disadvantage in some morally culpable manner; and
- the resulting transaction must be overreaching and oppressive.
The Claimant had agreed to the relevant bad leaver provisions as part of share sale agreement. At the time she resigned she held earn-out shares and loan notes which were subject to the provisions. The definition of bad leaver in this case included employees who voluntarily resigned. On resignation her earn-out payments and loan notes were forfeited as provided for in the share sale agreement in the case of a bad leaver.
After her resignation the Claimant averred that the provisions were as a result of a ‘unconscionable bargain’ and were thus unenforceable. She also suggested that they breached common law rules against penalty clauses.
The first instance Tribunal rejected the Claimant’s claim, holding that she had taken up employment voluntarily, and had resigned when she no longer wished to be employed by the Respondent, triggering the enforceable bad leaver provisions.
Decision and Comment
The EAT held that the Respondent could rely on the bad leaver provisions contained in the share sale agreement. The EAT found that the Claimant failed on the first limb of the test for an unconscionable bargain as she was able to take legal advice and had warranted in the agreement that she had sought professional advice confirming the bad leaver provisions were reasonable.
This case reinforces that bad leaver provisions are enforceable, but that is prudent for Employers to ensure that prospective employee shareholders seek legal advice before agreeing to bad leaver provisions.