The importance of careful drafting – discounting employee shareholders

October 2024

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As well as my series of Guides on areas such as share sales, joint ventures and shareholder investments and arrangements, I also do the occasional article which I put in the Updates and Tips section of my website. Appallingly I have not published one of these for nearly two years. Usually they are based on a recent court decision which covers new or interesting issues in the world of corporate or commercial law. Mostly I cover judgments made by the two bigger UK courts – the Supreme Court and the Court of Appeal – because these often involve changes or at least developments in the law. But some of the judgments in lower courts, particularly the High Court, are also useful or interesting because they highlight how courts interpret or apply the law in different circumstances. By definition any case which comes to the High Court usually addresses questions where the answer was not obvious to everyone. If it was, the parties would be unlikely to be spending lots of time and money in going to court to fight over them.

This recent High Court case addressed questions about leaver provisions in companies’ Articles of Association, and in particular questions about how various provisions should be interpreted. It highlights once again (a theme of many of my Updates and Tips articles) the importance of lawyers being very careful how they draft things, and not being complacent or taking things for granted. I will tell you briefly what the wording said and what the court was asked to decide. You can have a stab at guessing what the court decided before I tell you. And then I’ll remind you again of the importance of using a capable experienced solicitor when you are looking to put together any Articles of Association or other important legal agreement or document! And I’ll give you an example of a recent deal I was involved with where I spotted a defect in a top City firm’s drafting of a company’s Articles of Association which helped my client get the upper hand in negotiating exit terms when the company nastily forced them out…

Background

Many companies which offer share schemes to their employees or consultants have what are known as ‘leaver provisions’ in their Articles of Association. These are designed to tie the employees to the company. So for example the Articles will say that if an employee leaves, they must put their shares up for sale to other shareholders.

The Articles will then say what price those shares should be offered at. These provisions can contain all sorts of horrors for the employee shareholders. To begin with, there is always the issue of whether any shareholding in a company should be valued at a discount in the first place, simply because it is a minority shareholding. I addressed this issue in a rather good Update and Tips article Fair’s fair? Minority shareholders beware a couple of years ago – suffice it to say that if you ever agree to take a small shareholding in a private company, don’t assume that your shares will be worth anything like the same amount per share as the same types of shares held by a majority shareholder.

Additional ‘leaver provisions’ can provide for all sorts of other discounts to the price (down to almost nothing in some cases). These might depend, for example, on why the employee left or on how long they were with the company before they left. You often see expressions such as ‘good’ leaver’, ‘bad leaver’, ‘intermediate’ leaver or ‘early leaver’ being used. But what they actually mean and what the potential consequences might be in different circumstances will depend on the precise wording used in the Articles. Lawyers need to be very careful when drafting these provisions. As the two examples below show, they can often not quite get it right.

Recent High Court case

What was it about?

Mr Truman was a 24% shareholder in Syspal Holdings Limited (‘SHL’) and was also an employee of its subsidiary company Syspal Limited (‘SL’). He was a director of both companies. All the other shares in SHL were held by Syspal Capital Limited which was owned by a Mr Roberjot.

SHL’s Articles of Association said that if any ‘Employee Member’ ceased ‘to be employed as an employee, director or consultant of a group company (and does not continue in that capacity in relation to any Group Company)’ then they would be deemed to have served a transfer notice on the date of such cessation and therefore have to offer his shares for sale to the other shareholder(s). They went on to say that the offer price would be the ‘Market Value’ of the shares unless the transfer notice was deemed to be served as a result of ‘death, permanent incapacity or retirement at 65 years of age’, in which case the offer price would be the ‘fair value’. The big difference was that the ‘Market Value’ would be a lot less than the ‘Fair Value’ because a significant discount would have to be applied to reflect the fact that the offered shares were a minority shareholding.

Mr Truman’s 65^th birthday was on 24 May 2023.

After 42 years service with SL, Mr Truman was dismissed as an employee on 10 October 2022, and then removed as a director of SL on 3 November 2022. For some reason he wasn’t removed as a director of SHL. On his 65^th birthday he resigned as a director of SHL.

The court was asked to resolve the big question of when Mr Truman should be deemed to have served his transfer notice under the Articles in view of the wording in italics above?

What would you have decided?

I might have come to a number of possible different conclusions. Perhaps Mr Truman only needed to cease being ‘employed’ in any one of the three capacities mentioned (ie employee, director or consultant) and then not continue in that capacity, in which case the transfer notice should take effect on the date of his dismissal. Or perhaps the wording should mean that if Mr Truman continued in any of the three ‘capacities’ in relation to any group Company, then his dismissal as an employee should not itself trigger a transfer notice, and he therefore was only deemed to serve a transfer notice when he finally resigned as a director when he hit 65.

Or perhaps it might get more complicated; for example perhaps it might depend on whether Mr Truman’s employment contract stated that he was employed as a director, so that if he ceased to be employed as a director (because his employment terms had ended) the transfer notice should be triggered even though he still remained as a non-employee director (directors don’t of course have to be employees). But then, did the word ‘employed’ here actually mean ‘employed’ in an employment sense, or did it just mean ‘used’ or ‘acting as’ or something like that? After all, consultants aren’t employees, so the provisions wouldn’t make any sense at all in relation to consultants if the word ‘employed’ meant ‘employed’ in the employment sense.

The point really being that the wording in the Articles was not at all clear!

And what would have happened in other possible scenarios? For example would Mr Truman have been deemed to serve a transfer notice if he had just stopped being a director (either because he resigned or was removed) but had carried on being an employee? Or what if everyone had agreed that he should stop being a full-time employee but should carry on as a non-executive director whose experience and wisdom might continue to be useful, or perhaps as a consultant under a new consultancy contract? (And what if he hadn’t then signed a new consultancy contract until the day after he had ceased being an employee?…)

What did the High Court say?

Answer: it ruled in favour of Mr Truman. Then judge thought through the various possible arguments, and decided that his decision was ‘the more natural reading of the wording’ and ‘accords with commercial common sense’.

Case: Syspal Capital Ltd v Truman & Anor [2024] EWHC 1561 (Ch)

Takeways

• Often when I try to guess what courts might decide in cases where they are asked to look at poor wording on contracts, I factor in what might seem to have been the ‘fair’ decision, or what the parties might reasonably thought to have intended when they entered into any contract. This is what courts generally try to do. But in this Syspal Capital v Truman case it is not really clear what they had intended. On the face of it, however strange it might appear it does seem to have been the intention that despite Mr Truman having been employed by SL since he was 23, he was only intended to get the full undiscounted fair value for his shares if he managed to stay at the company in some capacity until he was 65 without resigning or being dismissed.

 

• Mr Roberjot could of course have avoided the whole case by making sure that Mr Truman was removed as a director of all the group companies at the same time as he was dismissed.

 

• When drafting any contract, particularly one involving possible long-term relationships, it can be very hard for parties and their lawyers to anticipate and provide for all sorts of different possible scenarios. Often it is impossible, and you just try to do your best. And you try to make sure that what you do draft makes as much sense as possible. Some lawyers are better at this than others. Please remember the importance of using a capable experienced solicitor when you are looking to put together any Articles of Association or other important legal agreement or document.

 

• Postscript

As well as helping people put joint venture, shareholder arrangements and other business deals together, I also help them work out where they might stand when they think they may be facing possible problems. I am not a litigation lawyer, although I do quite often work alongside litigation lawyers. But quite often the advice I give can help both sides to potential disputes (and their litigation lawyers) have an idea where they might stand if things did go to court, and this can help them to resolve things by agreement which can save a lot of time, effort, cost and grief by going too far down the litigation route.

One recent example involved acting for a shareholder employee whose company had been merged into another company a year or so earlier, and which had recently dismissed my client. As part of the merger the new company had issued shares to my client (and many other employee shareholders) in exchange for his shares in the old company. The new company had all sorts of detailed leaver provisions in its Articles which applied to these shares. I gave detailed advice on the potential implications of these provisions (which were not very clearly worded, even though they were produced by a leading City corporate law firm). They included ‘Bad Leaver’ provisions (as well as ‘Very Bad Leaver’ provisions!).  These included provisions saying that the price a leaver might get for their shares could be heavily discounted, for example there would be an 80% discount if the ‘Leaving Date’ was ‘1-2 years’. All the parties and their lawyers seemed to be taking for granted that these ‘Leaving Dates’ referred to a period of time following the date the new company’s Articles were adopted (meaning my client’s shares would be discounted by 80%). This is what one invariably expects to see in these VC-backed types of deal. I pointed out that the Articles didn’t actually set out any reference date from which the ‘Leaving Date’ should be calculated from, and produced a strong argument that in the case of my client (and all the other employees who had been issued shares in the new company) this reference date should actually be the date their original employment with the previous company had started. So my client should be entitled to the full undiscounted value. This produced some red faces with the new company and their law firm, who subsequently purported to change the new company’s Articles to state that the reference date should be the date the Articles were adopted (which might or might not work for those merged employee shareholders who are still employed by the new company). I understand that the law firm is also talking to its professional indemnity insurers!

 

If you are thinking of entering into any shareholder arrangements with business partners or investors or are having any issues or difficulties with existing arrangements please feel free to email me at andrew.james@onhandcounsel.co.uk to arrange a complimentary ‘Shareholder arrangements’ consultation where I can help you to identify what might be involved and how I can help. This will help you to avoid some of the pitfalls you might otherwise be exposed to, and give you the peace of mind of knowing that you have an approachable competent corporate lawyer ONHAND who can provide you with experienced, effective and cost-effective advice and assistance.

 

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