What should happen to an employee’s shares when they exit a business?
A recent court decision highlights the importance of compulsory share transfer provisions in the context of outgoing employee shareholders. Charles Mather from our corporate team considers the case and its implications.
Where a company has employee shareholders, protections should be in place to enable the company to force the transfer of shares held by employees that exit the business. Compulsory transfer provisions, whether in a company’s articles of association, a shareholders’ agreement or an employee share option agreement provide companies with such means of protection.
In Lee v GSquare Capital, the High Court considered the validity and enforceability of compulsory transfer provisions following the termination of a shareholder’s employment.
Good or bad leaver? What happened in this case
Compulsory transfer provisions in P2U Holdings Limited’s articles of association entitled it to transfer some or all of an outgoing employee’s shares for a period of 12 months from the employee’s termination date. The price to be paid for the shares was dependent on whether the employee was determined to be a good or bad leaver.
Daniel Lee, an employee and shareholder of P2U Holdings Limited, was made redundant. The board determined him to be a bad leaver, on account of an alleged breach of restrictive covenants.
GSquare Capital II LP, the majority shareholder of P2U Holdings Limited, sought to transfer Mr Lee’s shares for £1 each on the basis that he was a bad leaver, and identified him as such on the transfer notice drafted in respect of his shares.
Mr Lee disputed his bad leaver status, alleging that the transfer notice was invalid as it incorrectly identified him as a bad leaver. He further alleged that the compulsory transfer provisions relating to bad leavers in P2U Holdings Limited’s articles of association, specifically those that permitted the transfer of a bad leaver’s shares for £1 each, amounted to an unenforceable penalty.
What did the court decide?
The court held that the transfer notice was valid, as there was no requirement for a transfer notice to state the category of leaver into which an employee fell.
The court further held that the compulsory transfer provisions in P2U Holdings Limited’s articles of association in relation to bad leavers did not amount to an unenforceable penalty. The rationale was that, under the articles of association, leaver provisions were triggered regardless of whether or not the outgoing employee was a bad leaver. It was only the amount payable for Mr Lee’s shares that was materially affected by his leaver status.
Accordingly, the court struck out Mr Lee’s claims and granted P2U Holdings Limited and GSquare Capital II LP summary judgement.
What are the implications for other companies with employer shareholders?
Companies with employee shareholders should ensure their shareholders’ agreements, articles of association and any share option agreements provide them with a mechanism to acquire shares held by outgoing employees.
The case also shows the importance of drafting consistent leaver provisions in relation to compulsory transfers. Care should always be taken when drafting these clauses, to ensure that they have the best chance of standing up in the event of any challenge.
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