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New shareholder employee case on good/bad leaver provisions – David Lascelles

11.12.23

In Lee v Gsquare [2023] EWHC 3017 (Ch) (30 November 2023), the High Court considered two questions relating to mandatory transfer provisions following the termination of a shareholder’s employment, namely (1) was the mandatory transfer notice invalid if it incorrectly labelled the employee a bad leaver? (2) was the transfer provision unenforceable as a penalty?

Facts

The (simplified) facts were as follows:

Pursuant to the defendant employer’s articles of association, a departing shareholder employee could be required to transfer their shares.  The price to be paid to the employee for such shares depended on whether they were a good or bad leaver.

The defendant claimed that the claimant departing employee was a bad leaver because he had breached restrictive covenants.

The defendant included a statement that the claimant was a bad leaver in the transfer notice itself.

The defendant claimed that. as a result of the transfer notice and his bad leaver status, the claimant was required to transfer his shares for £1.

The claimant contended that he was a good leaver.  If so, and a valid notice had been served, he claimed to be entitled to £8m for his shares.

The claimant alleged, however, that the transfer notice was invalid as it wrongly stated he was a bad leaver.

In the alternative, he alleged that (even if the notice had otherwise been valid) the bad leaver provision amounted to an unenforceable penalty as: (i) any bad leaver status arose because of alleged breaches of restrictive covenants; and (ii) the repercussions of the clause applying were exorbitant.

Decision

The High Court (Master Pester) rejected the employee’s claims and granted the employer summary judgment.

Relying upon the lack of any express requirement for the transfer notice even to state the leaver category into which the employee fell, the Court held that the transfer notice was valid whether or not it correctly characterised the employee as a bad leaver.

The Court further held that the penalty doctrine was inapplicable.

The leaver provisions kicked in regardless of the reason for a person becoming a leaver.  Hence, the provisions were not dependent upon there being a breach and so the penalty doctrine was not engaged.  This was so even if the particular characterisation of a leaver as good or bad might (and on the facts did) depend on whether the employee was in breach of contract.

As the penalty doctrine did not apply, the clause was enforceable even if the result would otherwise have been exorbitant.

Comment

This is a useful decision for those seeking to enforce compulsory transfer provisions.  It builds on earlier authorities which had indicated the difficulties a former employee is likely to encounter in challenging the effectiveness of such clauses based on the penalty doctrine.

Further, although each case must turn on its facts, the detailed reasoning will provide useful ammunition to an employer seeking to resist arguments as to invalidity of transfer notices.

David Lascelles specialises in shareholder disputes including claims relating to mandatory transfer provisions.   Legal 500 independent guide to the legal profession recommend David as a tier 1 practitioner for company law disputes. 

 

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