UK: Option Schemes - clarity covers a multitude of sins

Last Updated: 9 August 1999

Share options can be a valuable benefit to employees and may make up a substantial proportion of a senior executive’s remuneration package. However, one area of difficulty is where a scheme provides for options to lapse upon termination of an executive’s employment. The case of Micklefield v SAC Technology Ltd in 1990 established the principle that an executive may still lose his right to exercise his options on termination, if that is what the scheme says, even where his dismissal was wrongful. In Micklefield the share option scheme stated that options would lapse if the employee ceased to be employed for ‘whatever reason whatsoever’ (sic) and that the employee would cease to be entitled to recover any compensation for loss of rights under the scheme in the event of termination ‘for any reason’. After Mr Micklefield was dismissed the High Court held that these rules were enforceable and therefore that Mr Micklefield was not entitled to recover damages for being unable to exercise his options as a result of his dismissal. Although Mr Micklefield was dismissed wrongfully (the company failed to give him proper notice) and even though it is generally an established principle of law that a party cannot be permitted to take advantage of its own wrongdoing, the High Court decided in this case that this principle was excluded as the provisions of the share option scheme were sufficiently clear to operate as an exemption clause.

The position established in Micklefield has now been called into question by the recent case of Levett v Biotrace International plc. Mr Levett was Managing Director of Biotrace and held an option to purchase shares in the company. Rule 5.7.1 of the Biotrace Scheme provided that if an option holder ‘becomes subject to the company’s disciplinary procedures his options shall be suspended and if [his] contract of employment with the company is consequently terminated...all the options then held by him shall lapse on the date of such cessation’. In October 1995, following a disagreement with a client of the company, Mr Levett was suspended and in a subsequent disciplinary hearing was dismissed without notice. The company refused to allow Mr Levett to exercise his options on the basis that in accordance with Rule 5.7.1 his options had lapsed. Mr Levett brought a contract claim arguing that he was entitled to exercise his options to purchase shares within his notice period, or alternatively to damages for the loss of that opportunity.

Though the company agreed that Mr Levett’s dismissal was in breach of contract it argued that his termination nonetheless fell within Scheme Rule 5.7.1, as his dismissal followed the application of the company’s disciplinary rules. On this basis, it argued, his options lapsed at the time of dismissal. The High Court disagreed and said that Rule 5.7.1 would only apply where the employment was lawfully terminated. As Mr Levett’s employment had been terminated in breach of contract the Court stated that Mr Levett should not be deprived of the benefit of the options as a result of the employer’s wrongdoing. The employer appealed but the Court of Appeal agreed with the High Court. It said that because the dismissal was wrongful, Biotrace could not argue that the termination fell within Rule 5.7.1. There was nothing in the Biotrace Scheme Rules (unlike the SAC Technology Scheme) that compelled the Court to conclude that it was intended that the employer could rely on its own breach of contract to bring the termination within that disqualifying rule and so to deny Mr Levett his options.

On closer examination it is unlikely that an employer’s ability under Micklefield to prevent an employee from recovering damages for being unable to exercise his options following a wrongful dismissal has been much affected by the Levett case. In Micklefield there was a clear and unambiguous clause which provided that options would still lapse even where the employee’s dismissal was in breach of contract. Had Biotrace included a similar clause in its scheme rules, it may well have been able to defend Mr Levett’s claim successfully.

However, the principle in Micklefield (i.e., that the employer can rely on its own breach of contract provided that it says so clearly in advance) could still be challenged by the case of Rock Refrigeration Ltd v Jones and Seward Refrigeration Ltd in 1997. While this case concerned the enforceability of restrictive covenants rather than options it established the principle that even where an employer includes a phrase in a covenant which attempts to apply the covenant whether the employee’s contract is terminated lawfully or not, that phrase will have no effect. The restrictive covenant will still be unenforceable against the employee where the employer has terminated the employee’s employment in breach. However, despite the potential counter-arguments available under Rock Refrigeration the message to employers is still clear. They should examine the provisions of their share option schemes to ensure that the rules of the scheme clearly and unambiguously provide for the lapse of the option on termination even where the employee has been dismissed unlawfully. This will certainly minimise the risk of a successful claim like Mr Levett’s.

Employers should also be aware that where the dismissal is unfair (and even if the scheme rules validly provide for the options to lapse on unlawful termination) an employee may be able to recover his option losses as part of his compensation for unfair dismissal. This route will certainly become even more attractive with the raising of the compensatory award limit for unfair dismissal to £50,000 later this year.

For further information please contact Susan Nickson, Trinity Court, 16 John Dalton Street, Manchester M60 8HS, UK, Tel: +44 161 830 5000.

This article was first published in the July 1999 Hammond Suddards Employment Bulletin

The information and opinions contained in this article are provided by Hammond Suddards. They should not be applied to any particular set of facts without appropriate legal or other professional advice.

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