Contracts of employment in a dog eat dog world

Sian Heard - Partner, Heard & Co. ...

Employees are your most important asset, but a business must also be afforded appropriate care and respect. Do your contracts of employment achieve this?

“A business’s most important assets are its staff”. A platitude, perhaps, but true. Yet there is real tension between the imperative of successful motivation and inspiration of one’s employees and protecting the business from the perennial attraction of greener grass. This is a particular challenge where shareholders demand greater profits, the government, quite rightly, requires demonstrable equality and transparency iscrucial for effective trading.

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1. The Contract

This is the foundation of a successful employment relationship. There is no legal requirement for contracts of employment to be in writing, although this is obviously highly desirable. All that is in fact required is a “written statement of particulars of employment” (Employment Rights Act 1996 S.1) which must be provided within two months of commencement of employment. A surprising number of employers have traditionally been content to let matters go at this basic statement. A well drafted contract in the commercial and increasingly mobile world is, however, indispensable. If a balance between employee incentives and client retention when employees leave is desired, that contract should, contain, in addition to the minimum terms referred to above, the following provisions, as a minimum1:

(1) a carefully drafted commission and/or bonus entitlement (I will refer to both as “bonus”).

(2) Termination provisions, with particular reference to what happens when an employee is under notice.

(3) Post termination restrictive covenants.

Careful and proportionate drafting is essential. Over enthusiastic drafting has invalidated entire clauses, and even contracts, for being too general.

2. The Bonus

Most trading and broking jobs are remunerated by way of salary, commission and/or a bonus. This brings with it its own particular issues-

Does a bonus form part of “wages”

Yes. The Employment Rights Act 1996 S.27(1) defines wages as:

“…any sums payable to the worker in connection with his employment including (a) any fee, bonus, commission, holiday pay or other emolument referable to his employment,whether payable under his contract or otherwise…”.

This matters because s.13 Employment Rights Act prohibits an employer from making a deduction from wages save, inter alia, where “.. the worker has previously signifies in writing his agreement or consent … In J Sweeney v Peninsula Business Services Ltd Mr Sweeney was employed as a sales executive. Shortly after commencing employment, Mr Sweeney signed a formal contract and a separate “commission document”, which read, inter alia:- If the Contract of Employment is terminated, either by the company through dismissal or by the sales representative through resignation, then special rules apply in relation to commission and bonus payments that might otherwise have been payable.

Commission payments on new and renewal business are only paid if the sales representative is in employment at the end of the calendar month when the commission payment would normally become payable. This does not apply in circumstances where the termination by the company or the employee is by virtue of retirement or redundancy. It is, therefore, an express contractual provision that an employee has no claim whatsoever on any commission payments that would otherwise have been generated and paid, if they are not in employment on the date when they would normally have been paid.

Mr Sweeney’s basic salary was £8,500 per year, and the commission element as very important to him. He left, and claimed he had been constructively dismissed, shortly before the bonus became payable. The EAT found in favour of the employer. They found that the commission clause had been incorporated into Sweeney’s contract and that payment of commission was contingent on his being employed at the date commission became payable.

Is a bonus payable even if the employeeis in repudiatory breach?

A bonus will usually be payable only at the end of the bonus period in question. Where the contract, without more, states that an employee is “entitled to receive a bonus, payable on …….. in each year..”, a pro rata entitlement is probably payable if the employee leaves, whether of his own accord or by way of dismissal before the end of the period for which the bonus is payable.

The contract should therefore provide that the bonus is a) payable only where the employee remains under contract on the date the bonus is paid and has not given or been given notice to leave, b) will not be payable in the event the employment contract is terminated as a result of a breach by the employee, and c) is subject to the absolute discretion of the employer (for more on iscretion, please see below).

Dismissal to avoid paying a bonus.

In Takacs-v-Barclays Services Jersey Ltd [2006] IRLR 877, an ex-Barclays employee claimed that his employer dismissed him to avoid paying his bonus. Takacs was entitled under his contract to a minimum bonus payment plus an additional bonus if he reached certain targets. He failed to reach those targets and was dismissed, without payment of the additional bonus, on notice shortly before the end of the first year of his employment. Takacs claimed that Barclays had recruited a team which took over the negotiation of a deal he had been working on. He claimed that Barclays was in breach of implied terms in the contract, being the duty of trust and confidence, a duty of cooperation in the achievement of targets, and a term that the company would not dismiss him specifically to avoid paying his bonus. Barclays tried to have the claims dismissed without a full trial. But it was decided that all these alleged breaches deserved a full hearing and a trial was ordered. The decision in this case was made at an interlocutory stage only and was subsequently settled. It was very fact specific and, for all these reasons, it needs to be treated with caution. The moral, however, is that where employees are promised performance related bonuses, changes in the systems and distribution of work which may affect their ability to meet their targets need to have a clear rationale and be implemented sensitively. Similarly, where a dismissal will mean an employee forfeiting a bonus, it is important that the dismissal may be justified objectively; the employee may otherwise claim the dismissal was solely to avoid the bonus payment.

The contract should provide that the bonus will not be payable if the employee has been dismissed or is serving notice.

This formed part of the decision in the Sweeney case considered above. It was more recently considered in Commerzbank AG v Keen AG [2006] EWCA Civ 1536). Keen was employed from November 2002 until June 2005, at which time he was made redundant following the closure of the desk he managed. Commerzbank operated a discretionary bonus scheme, which provided, inter alia, that no bonus would be paid if the employee was not employed by the bank or was under notice. Following his redundancy, Keen claimed damages for an alleged underpayment of discretionary bonuses for the years 2003 and 2004 and for non-payment of a discretionary bonus in 2005, the year in which he was made redundant. Commerzbank made an application for summary judgment on the basis that his claim had no real prospect of success, but was unsuccessful. The bank appealed. There were two critical issues before the Court of Appeal. First, the court had to determine whether the decision not to pay Keen any bonus for the work in 2005 was an irrational exercise of the bank’s discretion. Keen argued that the bank had benefited from his work until he was made redundant (i.e., a half year) but had not paid him for it. The court found that Keen was not entitled to any bonus payment for 2005 as he did not satisfy the clear contractual condition of being employed (in March 2006) when the bonus became payable.

Discretion

The term “in our absolute discretion” does not give an employer an unfettered discretion. The leading case is Clarke v Nomura (2000) IRLR 766. Mr Clarke was employed as a senior proprietary trader. He was, by common consent, a “profit machine” and in the first 12 months of his employment, he made profits in excess of £13.75 million pounds. For that period, he was awarded a bonus of £2.55 million.

In February 1997, Mr Clark was dismissed without, it transpired, good cause. He was given three months notice and placed on garden leave, and paid his full salary (a comparatively modest £125,000 per annum) until his employment ceased.

Nomura decided to award him a nil bonus for the period immediately before his employment ceased, even though in the relevant period he had achieved profits in the region of £6.5 million and, further, had secured another transaction which generated further profits of £16 million.

Clark’s contract of employment provided.

“…Nomura operates a discretionary bonus scheme, which is not guaranteed any way and is dependent upon individual performance and after the first 12 months your

remaining in our employment on the date of payment. As discussed, for the first 12 months of your employment you will be eligible for payment as per appendix A…”

Appendix A read, inter alia, as follows:-

“..The purpose of this document is to establish a clear outline of the parameters for a European Proprietary bonus scheme that is open and understood and that continues to provide senior equity management with discretionary elements dependent on overall performance and contribution to the business.

Bonus Calculation and Methodology

Trading activities generate a bonus pool of 20% of performance profit (ie revenue less expenses other than group overheads), after return on regulatory capital of 15%.

Up to 33.3% of individual bonus payment is at the discretion of Senior Management. This discretionary element is dependent on corporate contribution, team working, capital usage and due regard to risk..”

Clarke challenged the decision to award a nil bonus. In reaching his decision, the judge had first to determine what express parameters determined the bonus award and, second, whether that discretion was fettered by any implied parameters. As for express parameters, Clarke claimed that the key phrase was “individual performance” and that this referred only to profitability. He brought expert evidence to the effect that a proprietary trader’s main function is the increase of profitably, his talent for which was not in dispute. Nomura contended that “individual performance” was one factor alone. The judge endeavoured to reach a compromise. On balance, he preferred Clarke’s evidence that profitability was, in the context of assessing “individual performance” of a proprietary trader, the main factor but that “total contribution” was also a factor. Having thus determined the express parameters to which the discretion must be addressed (“individual performance” and “total contribution”), Burton went on to consider what implied fetters operated as a check on discretion. This question was construed in the light of a number of

authorities which had established that where an employer has the apparent right to “total discretion”, without any express parameters, he cannot exercise that discretion capriciously (Clarke v BET Plc (1997) IRLR 348) or without reasonable or sufficient grounds. White v Reflecting Road Studs Ltd (1991) ICR 733). The judge defined capriciousness as carrying with it aspects of “arbitrariness, domineeringness, or whimsicality”. Ultimately, he held that the correct test, when considering whether an employer had exercised his discretion legitimately, was “… one of irrationality or perversity (of which capriciousness would be a good example) i.e. that no reasonable employer would have exercised his discretion in this way…*

Clarke had been dismissed without good cause. Some of the factors given as a reason were a failure to attend management meetings, erratic time keeping, wearing inappropriate clothes. These reasons, which were in any event, not accepted as being appropriate, were, crucially, nothing to do with the performance criteria by which his bonus was, lawfully, to be assessed. In the circumstances, Mr Clarke won his wrongful dismissal claim and was awarded damages of £1.35 million. Subsequent cases have affirmed the Clarke v Nomura approach. In Horkulak v Cantor Fitzgerald International [2004] EWCA Civ 1287, a broker (Mr Horkulak) who resigned with two years left to run on a fixed term contract of employment. The contract stated that “the company may in its discretion, pay you an annual bonus”. Having successfully brought claims for unfair and wrongful dismissal (on the basis that he had been subjected to bullying and abuse by his superiors), Mr Horkulak claimed an entitlement to the bonus that he would have expected to receive had he remained working for the company for the full term of the contract. Cantor Fitzgerald resisted this claim, arguing that, as the bonus was discretionary, they would have been under no obligation to pay any bonus. The Court of Appeal approved Clarke v Nomura and held that Mr Horkulak was entitled to a “bona fide and rational” exercise of discretion by Cantor Fitzgerald in relation to the bonus scheme. In reaching this decision, the Court of Appeal relied on the fact the clause related to a high earning and competitive activity in which the payment of discretionary bonuses was part of the company’s remuneration structure. The Court of Appeal thought it clear from the wording and the purpose of the clause that it was intended to be read as a contractual benefit to the employee, as opposed to merely a declaration of the employer’s ight to pay a bonus if it wished. Unfortunately, the Horkulak decision offers no assistance as to how an employer may ensure that a discretionary bonus clause remains truly discretionary. This was considered in Keen v Commerzbank AG [supra]. Keen had challenged the bonuses awarded to him in 2003 and 2004, the two years before he was made redundant. The court held that the burden of establishing that the level of a discretionary bonus payment by the employer was irrational or perverse, where much depended on the employer’s discretionary judgment having regard to fluctuating markets and labour conditions, was very high, and, since the bank had a very wide contractual discretion the bank’s awards of bonuses to the claimant for those years could not be said to be irrational. In addition, the court noted that Keen’s assertions about the irrationality of the bank’s decision were not supported by independent or expert evidence. It held that his arguments were based mainly on recommendations that his boss had made to the bank regarding the size of the awards. The court made some other comments in its judgment that

will prove helpful to City institutions. It emphasised that it was not its function to usurp the bank’s exercise of its discretion and substitute its view for that of the bank. The court’s function was solely to decide on the legal limits of the bank’s discretion and whether it had acted within or outside these limits.

No guaranteed minimum

The Nomura decision is again of assistance here. You will recall that Clarke’s contract provided:

“…Nomura operates a discretionary bonus scheme, which is not guaranteed any way.”

The judge found that this meant that there was no guaranteed minimum payment. However, he also found that a legitimate exercise of discretion was still required. A legitimate exercise may mean that a nil bonus award is made, but the discretion must nevertheless be capable of analysis and exercised within the express and implied constraints.

3. Garden Leave

It used to be perfectly permissible for an employer, seeking to restrain an employee from working for any rival during his contractual period of notice, to ask that employee to stay at home, provided he was prepared to provide the employee with all his contractual benefits until the contracts expired, without insisting he perform any serves (Evening Standard Ltd v Henderson [1987[ ICR 589). However, this is now possible only where this has been expressly agreed. In William Hill Organisation Ltd v Tucker [1999] ICR 291, Mr Tucker gave only one months notice (his contract required six) of resignation, with the intention of joining a competitor. His employees sent him home, and agreed to pay his salary in full, but advised him that he was not to come into work. The Court of Appeal held that in the absence of such a clause, William Hill was in breach of such a contract. In reaching the decision, the Court held that the contract could and should be construed as giving rise to an obligation on the employer to provide the employee with work. Relevant factors were:

• the uniqueness of the employee’s post as the only senior dealer on the desk.

• Tucker’s particular skills would unless exercised frequently, diminish. The court held: “Although it is not a case comparable to a skilled musician who requires regular practice to stay at concert pitch, I have little doubt that frequent and continuing experience of the spread betting market, what it will bear on the subtle changes it goes through, is necessary to the enhancement and preservation of the skills of those who work in it…”

Placing Mr Tucker on garden leave in these circumstances amounted to constructive dismissal.

This left the employer in a very difficult position, as wrongfully terminating a contract, whether by way of constructive dismissal or otherwise, serves to release an employee from any restrictive covenant. In General Bill Posting Co Ltd v Atkinson [1909] AC118 a bill poster had been dismissed without notice. His contract had sought to restrict his right to trade as a bill poster within a certain radios for two years after the termination of employment. The House of Lords held that the employer’s wrongful dismissal had brought to an end all contractual terms. It is therefore imperative to incorporate a specific garden leave provision.

The period during which the employee may be placed on garden leave must not be excessive and there is a growing tendency to take into account any period spent on garden leave from any post termination non compete clause, as to which I comment further below.

4. Post Termination Restrictive Covenants

Post termination covenants are designed to restrain the activities of a former employee for a period after employment has come to an end. The basic position is that such covenants are void as being contrary to public policy, as they are by their very nature anti competitive and in restraint of trade. To enforce such contracts the ex employer can show that the covenant is no more than is reasonably necessary to protect “his legitimate business interests”. The burden of proof is on the employer, who must show that the covenant is reasonable in terms of its geographic extent and period. A “legitimate” interest is proprietary in nature. It will include such matters as trade connections, customers’ lists, trade secrets and other confidential information. Particular post termination restrictive covenants include the following:

(a) Non compete and non dealing clauses

Non-compete provisions endeavour to prevent a former employee contacting his former employer’s clients for a particular period. Such a clause is difficult to police and, if enforceable, would not prevent a client contacting the ex-employee. A non-dealing covenant achieves greater protection and prevents a former employee working for a client - even if that client wishes to work with the exemployee. Such provisions are, however, onerous and will be upheld only if reasonable. They must, as a minimum, be expressly limited to those clients whose business was handled by that employee.

In Cantor Fitzgerald (UK) Ltd v Wallace [1992] IRLR 215. A restrictive covenant sought to restrain employees (brokers dealing in Euro bonds) from working in any competing business for a period of six months after the termination of their employment. The employees resigned and joined a competitor. Cantor sought an injunction and argued that the five employees had built up relationships of trust with the various traders with whom they had worked during their employment with Cantor UK and that, because of this, they would continue to deal with those traders after leaving that employment, thus causing unquantifiable loss and damage to Cantor UK. It was argued that the restrictions were necessary for the protection of Cantor’s UK trade and should be enforced. The Court held that an employer was only entitled to protect a proprietary right recognised as a legitimate

object of protection. There was no proprietary right in the connection built up while the employee was in employment; such connections were based on nothing more than the personal quality of the employee.

(b) Covenants seeking to prevent an employee “poaching” a former colleague

Non-poaching covenants were, until relatively recently, considered unenforceable. The courts now, however, accept that employers have a legitimate business interest in maintaining a stable workforce, and a ‘non-solicitation of staff provision’ can, therefore, be effective. It is imperative, however, that the clause is carefully drafted .It should, for example, be restricted in duration and refer only to those people with whom the ex employee worked directly.

(c) Geographical Extent

A clause will be struck down if its geographical ambit is unreasonably wide. Thus in Office Angels v Rainer Thomas [1991] IRLR 214, the Court of Appeal struck down a clause which sought to prevent a manager and consultant from working within a radius of 1000 metres of their branch. The branch concerned was in the City and thus prevented them from working in most of the City of London.

(d) Duration

The approach here should not be ‘how long can the employee be kept out’ but ‘how long do I reasonably need to protect and repair my business?’ Of increasing relevance here is the length of any preceding garden leave provision. In TFS Derivatives-v-Morgan [2005] IRLR 246, for example, Morgan’s contract of employment contained a clause restricting competition for a period of six months following the termination of his contract less any period spent on garden leave”. On giving 3 months’ notice, he was put on garden leave for the notice period. TFS then sought to enforce the non-compete clause which after permitting set-off was for a period of 3 months. Morgan argued that the non-compete was an unlawful restraint of trade because TFS could have adequately protected itself by providing for six months’ notice on garden leave. This would have been a more flexible and more reasonable restriction to impose and employers who wish to restrict the future employability of a former employee should be prepared to pay for such restrictions. The judge was invited, in the absence of decisions on the relationship between garden leave and post termination restrictive covenants to take the opportunity to say something about the reasonableness and greater attraction of garden leave clauses generally. This did not form part of her decision, but she commented that garden leave could be regarded as “more onerous” than a post-termination restriction, since it would stop the broker from exercising his skills entirely for 6 months. She also suggested that a 6 months’ enforced period of garden leave, even if in accordance with an express term of the contract, would be likely to face resistance on the basis that its use would amount to a breach of the implied term of trust and confidence. In a more recent decision, however, a more robust long term non-compete clauses was upheld. The case was Extec Screens & Crushers Ltd v David Rice [2007] EWHC 1043. The employee argued that a period of 3 months spent on garden leave should be deducted from the eight months post termination non compete clause. The judge disagreed, however. That was not what the non-compete clause said; it referred to a period of “8 months after the termination of the employment”. A total of 11 months was not, in his judgment, excessive period and as periods of up to 12 months arecommonly upheld by the courts, he found no reason to cut down the extent of the non compete clause.

(e) confidential information and trade secrets

During employment the employee owes the employer a duty of confidence which may be stated in the employment contract, but if not it will be implied by law and restrictive covenants will usually expressly prevent the employee from disclosing confidential information after employment ends.

However, what information is truly “confidential” and for how long can it survive the end of employment?

Examples given by the Court of Appeal in Faccenda Chicken v Fowler [1985] 1 All ER 724 included ‘secret processes of manufacture such as chemical formulae’, ‘design and special methods of construction’ and ‘other information which is of a sufficiently high degree of confidentiality to amount to a trade secret’ The court also held that the obligation of confidence existing postemployment was more restricted than that which operated during the currency of the employment and identified four aspects which are relevant to differentiating between trade secrets and other information which could not be protected

post-employment, and the most relevant of these for our purposes are:

(i) Has the information been given to only a limited number of employees

(ii) Has the employer impressed on the employee the confidentiality of the information

(iii) Can the confidential information be easily separated from other information acquired by the employeeduring the course of employment.

It is also important to differentiate between confidential information and know-how, which is the general skill and knowledge that an employee acquires during the course of employment and is entitled to take to a future employer:

See FSS Travel & Leisure Systems Ltd v P.A. Johnson & The Chauntry Corporation Ltd [1998] IRLR 382.

In summary, therefore, where an employer has information that he wishes to protect care should be taken to identify that information as confidential, to separate it from other non-confidential information and to restrict its availability within the workforce.

5. Severability Provisions

It is essential that any contract, which seeks to incorporate restrictive clauses, contains a clause which provides that, in the event of any one provision being declared void and unenforceable, the other parts of the contract shall nevertheless remain valid, and the contract shall be read as though such a provision formed no part.

6. Can Restrictive Covenants Be Imposed After Commencement Of Employment?

In Willow Oak Developments Silverwood [2006] EWCA Civ 660, the employer required existing employees to enter into widely drawn covenants restricting their business activities after their employment ended. The claimants refused and were dismissed.

Upholding complaints of unfair dismissal, the employment tribunal held that the covenants were so unreasonable that the refusal was not a “reason of a kind such as to justify the dismissal” for the purposes of section 98(1)(b) of the Employment Rights Act 1996, nor, alternatively, could the claimants’ dismissals be regarded as fair under section 98(4), since there had been a lack of consultation, no proper opportunity for the employees to understand the covenants and no warning that a failure to agree might result in dismissal. The Employment Appeal Tribunal dismissed the employer’s appeal, holding that, although the employer’s reason for dismissal fell within section 98(1) (b), the claimants’ dismissals were unfair under section 98(4). On appeal by the employer, the Court of Appeal held that although an employee’s refusal to accept covenants proposed by the employer for the protection of his legitimate interests could be a reason “of a kind” such as to justify dismissal under section 98(1) of the Employment Rights Act 1996, the claimants’ employer did not in all the circumstances, in particular in giving no warning that failure to agree the new terms might result in dismissal, act reasonably, as required by section 98(4), in treating that reason as a sufficient reason for dismissing the claimants and, therefore, the dismissals were unfair.

7. Conclusions

Lucrative lures from competing employers have, in the last ten years, created a volatile recruitment and employee retention environment. It remains to be seen whether the credit difficulties of 2007 and 2008 will lead to a restriction of the reward culture that has rewarded risk and short term gain over long term stability. Whatever lies ahead, however, a prudent employer should ensure that employment contracts for key staff are routinely and regularly reviewed. His objective is to reward his employees and protect his shareholder’s interests and in doing so, his mantra should include realism, proportionality and reasonableness.