Money for nothing
12 May 2003
When it comes to scoring easy political Bro-wnie points with the public, there are few targets more rewarding and easier to hit than denouncing the overinflated payoffs to failed company directors. But is there a legal solution to the fat cat problem? In the last few months, outlawing executive excess has been variously described as "a legislative minefield" which generates "unnecessary legal complexity and uncertainty" by the Department of Trade and Industry (DTI) and the Confederation of British Industry (CBI) respectively.
Nevertheless, it is unlikely that the protestations of lawyers will stop the politicians from having a crack at it. A private member's bill from a Tory MP proposed a legislative answer earlier in the year, but it was roundly kicked into touch. More recently the Trade and Industry Secretary Patricia Hewitt acknowledged "entirely justified fury" among shareholders and is putting finishing touches to her 'Reward for Failure' consultation paper, which (according to the rumour mill) will also involve changing the law. Proposals look likely to include cutting the length of directors' contracts from a year to six months and linking payoffs for directors to performance, regardless of what they have negotiated in their contracts.
It is not hard to see why ministers want to be seen to be tough on 'golden goodbyes' amid the growing anger aimed at poorly-performing executives walking away with millions despite lacklustre performances in the boardroom. Most recently, Sir Brian Moffat signed off the end of his chairmanship of Corus (formerly British Steel) by announcing 1,150 job cuts, with possibly a further 2,000 to come this month. However, Moffat, who will leave with a £300,000-a-year annual pension, still managed to steer through an executive pay scheme that would allow Corus bosses to receive bonuses of up to 30 per cent of their salary. Before that, the head of insurance company Royal & SunAlliance Bob Mendelsohn gained £1.44m after he left his job last year. Adam Singer of Telewest and Ken Berry of EMI also departed with multimillion-pound payoffs, even though their companies were in trouble.
Ronnie Fox, senior partner at Fox Williams, has advised numerous companies on such payoffs and believes that much of the negative press is undeserved. "A lot of this criticism comes from people who've never had the responsibility of running a large company and had to accept the responsibility for the jobs of thousands of people or the management of plant machinery costing millions of pounds," he says. "They don't understand the complexities of business." Fox recently acted for Marconi deputy chief executive John Mayo, who was exonerated in the recent Financial Services Authority (FSA) investigation into the circumstances surrounding the company's collapse. Mayo (along with chief executive Lord Simpson) was lambasted in the press for the £1m payoff he received.
Stefan Martin, an employment partner at Allen & Overy (A&O), points to "maybe a deliberate failure [on the part of the media] to appreciate that companies aren't paying out because they want to award poor performance, but because there's a legal obligation under the contract".
Fox is a fan of the free market and believes that it operates efficiently even in this contentious area. "Large businesses don't become successful businesses unless they're very sensitive to what the marketplace is paying," he says. "Most companies pay what the market demands." In the case of Marconi, the solicitor points out that the FSA specifically exonerated his client.
Nevertheless, it was the outcry over such supposedly unwarranted golden goodbyes that prompted Tory MP Archie Norman to draft his own private member's bill. The former Asda boss proposed an apparently modest amendment to the Company Law Act so that a board would have to demonstrate that it has taken into account the performance of a departing director. He consulted Macfarlanes when preparing his bill.
The challenge for Norman's bill was how to legislate against poor performance and, in particular, how to define corporate failure. "The solution that Archie Norman was proposing was to put in place a new legal duty upon directors to consider whether a payment was fair and reasonable, having regard to the poor performance of a departing director, and leaving that concept deliberately very vague and one to be worked out by the courts," explains SeáLavin, an employment partner at Macfarlanes.
The proposals came under ferocious attack from many parts of the business community. "Blatantly bonkers," was the view of the Financial Times, which accused it of undermining "contract law capitalism's legal bedrock", and said that it was "eminently challengeable" under the Human Rights Act (HRA).
As Lavin points out though, how on earth does a company write adequate measures of performance into a contract? "Imagine trying to negotiate a service contract for a chief executive in 2003 that includes in it strict criteria for performance with which you will later fire that person in 2007," he says. "The relevance of such criteria might well be questionable, and if such criteria can't be specific, they would be too general."
However, forcing a link between performance and pay does not sit well with the basic tenets of contract law. "It would be a fundamental rewriting of the parties' ability to actually negotiate whatever terms they think are appropriate," comments Martin at A&O. "How could you tie a particular person's actions to the performance of a company, when all the other companies in that sector aren't doing well?" He reckons the bill was not taken too seriously, but that it did serve to focus the discussion "because the Government has realised that there was a large degree of support for these measures".
As Fox observes, success or failure is something of a relative concept. "In the funds management industry last year, you were doing very well if you only lost 10 per cent of the value of the funds. You might think that's a failure," he says. "What happens if a foreign government imposes a levy which suddenly wrecks a business, or someone's running an airline that serves the Asian market and their revenue sinks like a stone because of Sars. Is that their fault?"
The revival of a discussion about the possible link between performance and payout prompted by Hewitt's recent comments has prompted an angry outburst from the Confederation of British Industry (CBI). "This government's got form when it comes to putting headline-grabbing proposals ahead of practical initiatives," complained CBI chief Digby Jones. "This week's raised the spectre that ministers might be tempted to play to the gallery. We must prevent that happening." He added that it would be "totally impractical for the law courts to pass judgment on whether a chief executive had failed".
Given that the criticism levied at the proposals by the DTI was that they represented an infringement on the freedom to contract, Lavin notes the irony of ministers now considering capping directors' contracts at six months and, as a consequence, cutting damages for the early termination of a contract. "If that isn't an infringement on contracts, I don't know what is," he adds.
According to Fox, such a move would also place UK companies at a disadvantage in the world marketplace. "In order to encourage people to take on large and challenging jobs, we're competing in an international market and people want job security. At the top of industry, it may well be that if that position doesn't work out it would take an age for somebody to get another job, and there've been quite a number of cases where people have left a job as chief exec never to have another comparable position," he says. "So who'll take on those sorts of jobs with their challenges?"
The National Association of Pension Funds (NAPF), which represents a quarter of the UK's shareholdings, has been pushing for a voluntary code to address these problems as opposed to statutory requirements. Director of communications at NAPF Andy Fleming argues that guidelines, in the form of the bible of company best practice that is the 'Combined Code', are already working in recommending 12-month contracts. "They've brought about significant changes over the last two to three years in relation to the length of service contracts for executive directors," he says, adding that last year more than 60 per cent of the top 50 companies had all of their executives on contracts of one year or less. He continues: "But we'd acknowledge that in some cases it would be necessary to put people on longer than one-year contracts if, for example, they were a struggling company and needed a brilliant new chief executive to come in and sort things out." He says the relatively crude measure of cutting notice periods does not have any link with the rewarding (or not) of failure.
NAPF, together with the Association of British Insurers (ABI), published in December a statement of best practice calling on companies to ensure that "they do not write contracts that commit them to pay for failure", which could provide a "reference point" for its members when voting on remuneration reports at annual meetings. The two influential groups also took exception to Norman's idea of leaving it to the courts to decide what was "fair and reasonable" for underperforming executives to receive. They argued that the bill was unlikely to curb payoffs. "Perversely, it could lead to a situation where legal precedent tended to confirm departing directors' rights to large payments, making it even harder to achieve results through shareholder pressure or moral persuasion," he warns.
Similarly, an inevitable and counterproductive effect of statutory limits on the duration of contracts would be to drive up compensation rates. As Julian Hemming, a partner at Bristol-based Osborne Clarke and chairman of the Employment Lawyers Association, says: "If you give less security on the termination of employment to an executive, they'll just demand more money up front."
Another measure rumoured to be in the forthcoming consultation paper is paying out compensation in stages. According to David Coleman, a corporate lawyer at Macfarlanes, this is already a common US practice which avoids the "double whammy" by preventing the exiting director from pocketing a massive amount and then walking straight into a new job. But he adds that this, too, also fails to "tackle the issue of failure". It was an idea included in the NAPF/ABI statement.
According to Lavin, one aspect of Norman's bill that has been overlooked related to disclosure, or as he phrased it, "the embarrassment factor". The bill called for an obligation upon the company to disclose on request from shareholders the amount of pay agreed on termination. "Presently, the law allows a company to pay a severance payment in May 2003 and for it not to be disclosed until its report and accounts are published in 2004, by which time it's really a dead issue," he explains. The bill stated that when a severance payment had been made or agreed, a query from even a single shareholder would force the company to post the size of the payout on its website. "That was an uncontroversial and a good idea, and I wouldn't be surprised if the DTI picked that up in some shape and form," he adds.
As far as anything tougher goes - such as a six-month cap on contracts - Lavin believes it would be "a radical step. It's very hard to come up with a legislative solution that isn't radical," he adds. "And I don't know if the Government has the courage or whether it would even be wise to do that."
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