Executive Termination Payments and Shareholder Approval
In response to what has been described as "community outrage" the Government has recently announced its intention to introduce significant amendments to the Corporations Act 2001 (Cth), which will significantly limit the level of termination payments that can be made to key executives without shareholder approval. This is likely to have a material impact upon the structure of executive termination payments and executive remuneration more generally.
The government has announced that significant amendments have been announced to the Corporations Act 2001 (Act) to limit the level of termination payments that can be made to senior executives without shareholder approval. Under section 200 of the Act, as currently drafted, shareholder approval is required if termination payments paid to people who hold a "board or managerial office" are in excess of the amount calculated in accordance with a formula set out in the Act. The formula is complicated and the amount that can be paid without shareholder approval depends on the individual's length of service but in summary, a person holding a board or managerial office with seven years' service with the company can receive a maximum of seven years' total remuneration, without the need for shareholder approval of the payment. This is obviously a very significant amount.
Nature of Proposed Amendments
The amendments to the Act that have been proposed by the Government are intended to reduce the amount that can be paid to an executive on retirement from their office, without the need for shareholder approval, to 12 months' base salary. This is the maximum amount regardless of length of service. It represents a significant reduction from the current maximum, particularly for those with more than one years' service, not just in terms of the potential multiplier, but also because the amount is calculated by reference to base salary. It will not, therefore, take into account any bonus or other incentives, such as the value of any options or incentives that may vest on termination.
In addition, the number of people who will be captured by the changes to the Act is likely to increase significantly. At the moment, section 200 only applies to people who hold a "board or managerial office", who are defined as people who hold the position of director or who hold a managerial office who have held the position of director in the 12 months preceding the termination or retirement from office. The proposed amendments vary this and the provisions of section 200 will apply to all "key management personnel". Key management personnel are defined in the AASB as people who "have authority and responsibility for planning, directing and controlling the activities of the company, directly or indirectly and will include any executive or non-executive director".
Impact of Proposed Changes
As a result of the proposed amendments, it is likely that the termination provisions in most executive service agreements which contain a notice period of six months or more will require shareholder approval in order to make the termination payment, particularly, where the individual has significant bonus, incentive or equity entitlements that will become payable or vest on termination.
A number of issues arise from this. An important question will be when shareholder approval will need to be sought from the shareholders. This could be done at the time that the contract is entered into or at the time of termination. This will, of course, depend upon the situation, but one can anticipate that the shareholders may be more willing to approve a greater payment at the outset of the relationship.
There is, of course, a risk that the shareholders will not approve the level of proposed termination payments and because of this risk, the executives may well seek to effectively "front-load" their contracts, that is to negotiate better pay and benefits during the course of the employment to compensate them for the fact that they may not receive the golden handshakes which they have customarily been led to expect. In particular, we may see more emphasis on base pay and fixed salary rather than variable pay. It can also be expected that there may be an increase in executives seeking fixed term agreements, so that the company's right of termination will be limited, and executives will be guaranteed a certain level of income for a specific period.
It will of course be essential for all executive service agreements applying to key management personnel to be reviewed to ensure that termination provisions are subject to the Act and are conditional upon the relevant shareholder approval being obtained. The relevant steps will, of course, have to be taken to obtain the requisite shareholder approval.
The full detail of the amendments to the Act have not yet been published. However, on the basis of the Government's press release, it is anticipated that the changes will only apply to contracts entered into after the amendments come into force. That is, the current provisions of the Act will apply to agreements that are already in place. However, an interesting question will arise in relation to contracts that are varied, for example, by increasing the remuneration or by amending any of the other terms and conditions. It is possible that a simple variation of an existing contract could result in the contract itself falling within the scope of the amended legislation.
The Government has also announced that it has commissioned the Productivity Commission to review the regulatory framework for executive remuneration more generally. This enquiry will last for nine months and is intended to be a "broad ranging" examination of all regulatory arrangements applying to the remuneration of executives and directors. We will, of course, be keeping clients informed of any significant changes that are introduced as a result of the Productivity Commission enquiry.
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