In the recent case of Signia Wealth(“Signia”) and Vector Trustees Ltd(“Vector”) , the High Court of Justice ruled that Signia’s bad leaver provision did not breach the penalty doctrine, and was therefore enforceable.
The case originated when Ms Dauriac, managing director of Signia, following an already deteriorated relationship with the founder of Signia, resigned during a disciplinary proceeding for an expenses claim. Based on Signia’s articles of association, directors or employees are obliged to offer their shares back to the company when leaving. The price of the shares were to be determined based on whether or not they were deemed to be a “bad leaver”, in this situation, the bad leaver would get a price much lower than the market price. Ms Dauriac was deemed to be a bad leaver by the company, and her 49% shareholding in Signia was compulsorily transferred from her, at a price of £2 for all of her shares, as per Signia’s articles of association (the “articles”). This amount was low and punitive, regardless of the fact that she was deemed to be a bad leaver.
Ms Dauriac contested the fact that she was a bad leaver but argued that even if she was considered a bad leaver under the company’s articles she claimed that the difference in price between a bad and a good leaver constituted a penalty, and therefore the provision was not enforceable.
Under English law, a penalty is a secondary obligation which, in case of a contractual breach of a primary obligation, imposes a disadvantage to the contract breaker that is out of proportion to any legitimate interest of the other party, and is therefore unenforceable (Cavendish Square Holdings B.V. v El Makdessi ) (“Cavendish v Makdesi”).
The court found that Ms Dauriac was a leaver due to her own resignation and indeed a bad one, according to the company’s articles, however, they held that the penalty doctrine did not apply to this case, and that even if it did, the bad leaver provisions were not considered a penalty. This was because the enforcement of these provisions was due to the company’s articles and not a breach of a primary contractual duty. Ms Dauriac was therefore awarded by the Court an amount of £750.000 for the price of all her shares. The court determining that in the situation this was a fair value valuation, albeit still far below their market price.
This case highlights the importance of well drafted leaver and compulsory transfer provisions in order to tie shareholding to people involved with the company’s business development. As well as highlighting how these types of provisions can be used as an effective tool to retain staff, as “bad leavers” are forced to sell their shares at a reduced price. Moreover, this case also alleviates concerns of commentators on the enforceability of bad leaver provisions, especially since the judgement in Cavendish v Makdesi.
For more information on or any guidance or advice in drafting your commercial contracts, Cleveland & Co external in-house counsel, your specialist outsourced legal team are here to help.