Executive termination payments and shareholder approval
On Tuesday 5 May 2009, the Federal Government released an exposure draft of its proposed amendments to the Corporations Act 2001 (Cth) to lower the threshold at which companies require shareholder approval for termination payments. The new cap will apply to a broader category of individuals and cover more kinds of remuneration payments than is presently the case. Importantly, the proposal is that the new laws will not (on commencement) apply retrospectively to existing contracts that have already been settled.
The Federal Government has now released its exposure draft of legislation which is designed to limit the level of termination payments that can be made to senior executives without shareholder approval. The Corporations Amendment (Improving Accountability on Termination Payments) Bill 2009 (Bill) proposes amendments to the Corporations Act 2001 (Act). The Act currently provides that shareholder approval is required if the amount paid on termination to a director (or a senior manager who has been a director of the company in the previous year) is in excess of a prescribed formula. The relevant amount is determined by the individual's length of service, but the maximum amount is currently seven years' total remuneration.
Reduction in cap
The Bill proposes to reduce the cap for shareholder approval to one year's base salary, irrespective of length of service (except if the person has served for less than a year, when the threshold is lower again). This is a significant reduction in the potential payment that can be made without shareholder approval, both in terms of the potential number of years' pay, but also by virtue of the fact that the reference point when calculating the threshold is the individual's base salary in the relevant period, rather than total remuneration. The threshold will therefore no longer take into account any other benefits, such as bonuses or other incentives.
Identifies payments "in connection with departure"
The draft regulations accompanying the proposed Bill purport to clarify when a benefit is given in connection with a person's departure from office – that is, whether or not particular payments require shareholder approval. Importantly, not only are payments in lieu of notice taken to be a benefit in connection with a person's departure from office, but so are any accelerated or automatic vesting of options, apparently in any circumstances.
Broader scope of individuals and benefits to which the cap applies
The categories of individuals to which the cap applies will be expanded. The proposal is that for disclosing entities (entities that have enhanced disclosure obligations under the Act, for example listed companies and some regulated managed investment schemes), the cap will apply not just to directors, but to key management personnel and the five highest remunerated company executives (if different).
Also, the category of benefits to which the cap applies is to be more specifically set out. Benefits will be identified as either "in" or "out" for the purposes of the threshold. For example, the payment of any voluntary out of court settlement, or a superannuation payment in excess of the statutory amount, will be "in", that is they will be taken into account in determining whether the payment has reached the threshold amount. However, deferred bonuses and payments from certain defined benefits superannuation schemes are "out".
Increased penalties and prescribed times for approval
There will also be significantly higher penalties, with potential fines for individuals of up to $19,800 (increased from $2,750) whilst retaining the option of six months imprisonment, and for corporations of up to $99,000 (increased from $16,500), for payments without shareholder approval.
The time at which shareholder approval must be sought for payments in excess of the threshold is also prescribed. Under the current legislation, if shareholder approval is likely to be required, it can be obtained at any time, including the time that the relevant contract was entered into. However, under the amended legislation, any shareholder votes on termination benefits must take place at a general meeting that occurs after the executive's departure. This is said to give shareholders the opportunity to assess termination payments in the context of the recipient's actual performance. In addition, the relevant meeting must not have been called for the sole or dominant purpose of passing the resolution. Depending upon the timing of any relevant termination and the next scheduled general meeting, this may well result in uncertainty for both the executive and the company in terms of the extent of their entitlements and obligations on termination.
Operation is not retrospective
Importantly, the proposal is that on commencement, the new laws will not apply retrospectively to existing contracts that have already been settled. However, the variation of existing contracts with respect to remuneration and other terms and conditions may bring the contract within the scope of the amended provisions.
The Bill is open for comment during public consultation until 2 June, 2009. The changes are separate from the Productivity Commission review of the regulation of executive remuneration, which was set up by the Federal Government in March 2009.
Impact of Proposed Changes
In light of the significant increase in potential penalties for breach, it is particularly important that companies ensure that they do not breach the new provisions. Given the political sensitivity of this matter, we anticipate that there will be an increase in prosecutions for any breach.
The significant reduction in the threshold is likely to see a material increase in the number of circumstances where shareholder approval is required. It is likely that the termination provisions in executive service agreements which contain a notice period of six months or more will require shareholder approval, particularly where the individual has significant bonus, incentive or equity entitlements that become payable or vest on termination.
Also, executives may well seek to "front-load" their contracts by negotiating better pay and benefits during the course of their employment, with a greater emphasis on base pay and fixed salary rather than variable pay. It can also be expected that there will 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 specified period.
Executive service agreements applying to key management personnel should provide that termination provisions are subject to the Act and are conditional upon the relevant shareholder approval being obtained. The relevant steps will, of course, then have to be taken to obtain the requisite shareholder approval.
The changes will not have retrospective effect, which will mean that contracts in existence at the time that the amendments come into force will be subject to the thresholds as they exist now. Companies may wish to ensure that they have current and up to date contracts for senior executives prior to the introduction of the changes. However, the question will arise as to what will happen if those contracts are varied in the future, for example if remuneration is increased. There is a risk in these cases that the contracts and the termination payments made under them will become subject to the new thresholds. Hopefully the Government will provide some clarity in relation to this issue.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.