Reissued ABI/NAPF Guidelines

Reissued ABI/NAPF Guidelines on Executive Director Employment Contracts and Severance Payments

On 18 February 2008 the Association of British Insurers (ABI) and the National Association of Pension Funds (NAPF) issued an updated joint statement of best practice on employment contract terms and severance policies for executive directors in quoted companies. The ABI and NAPF represent the interests of the leading UK institutional investors and the key intention behind the guidelines is to prevent departing executive directors from receiving unjustified termination payments in cases of under-performance.

Unlike the ABI guidelines on executive remuneration (including employee share schemes), which are revised annually in December, these guidelines have not (other than in one minor respect) been revised since December 2002.

Although the guidelines have been rewritten, there are relatively few changes of substance. The most notable changes are even stronger encouragement for contracts with notice periods of less than one year, mention of the Remuneration Committee reserving the right to reclaim bonuses if corporate financial performance has to be restated significantly, and reference to the Remuneration Committee periodically reviewing contracts (with the implication being that there could be changes to the executive director’s detriment) if the contract has become markedly out of line with best practice.

The guidelines are substantially the same as the previous version of the guidelines, although they have been substantially re-formatted. Perhaps following a general trend towards having general rather than detailed guidelines, the guidelines are now based around eight core principles, with additional guidance provided as to shareholders’ expectations on contract terms, notice periods, severance payments, pensions and disclosure.

Key new points include:

• Companies are required clearly to disclose key elements of directors’ contracts on their websites and summarise them in the Remuneration Report. When we contacted the ABI about this, they said that it was doubtful whether companies that already give full disclosure in their Remuneration Reports would have any further disclosure obligations. It is interesting to compare the US experience, where many quoted companies are increasingly obliged to give greater disclosure in this area.
• Companies should fully disclose in their Remuneration Report the constituent parts of any severance payments and justify the total amounts paid and each constituent element. Many companies only disclose a total figure for severance payments. Disclosing the breakdown of the figure could potentially be awkward and re-open wounds when it is published, and companies may well wish to avoid this situation, although investors may understandably require such information, in order to judge whether the payment was justified.
• Remuneration Committees should periodically review executive director employment contracts, considering whether contract provisions comply with the guidelines and with company policy. Employment law prevents an employer from unilaterally amending a contract of employment to disadvantage the employee. The implication of the guidelines is that contracts should expressly be drafted so as to be capable of being amended to the executive director’s detriment (without his consent, if necessary) in cases where the contract has become significantly out of line with best practice. It is difficult to see how such amendment could be forced on existing employees without their agreement. What is probably in mind is the reduction of notice periods over the years, where companies were often powerless to implement reductions unilaterally or without paying compensation. The guidelines seek to avoid similar issues having to be addressed in the future. Compliance can perhaps best be achieved, if thought desirable, by including an express clause in the employment contract on this point.
• The Combined Code does not look favourably on contracts with notice periods of 1 year or more. Most of the offending contracts have, however, now been brought into line. But the new guidelines have gone further, and state that contracts should have reasonable notice periods, with the 12 month notice period as a cap. They strongly encourage boards to consider shorter notice periods than the standard 12 months. If longer notice periods are required for exceptional reasons, such as to entice an executive director into a struggling company, the termination provisions of the contracts should be fully disclosed and justified.
• Remuneration Committees should consider reclaiming bonuses if it is subsequently discovered that performance achievements have been significantly mis-stated. In recent years, there has been a fair amount of discussion on how this can be achieved, with lawyers struggling to come to any easy conclusion. There has even been an investor working party on this. However, any clawback provision in a contract would need to be precisely drafted and carefully handled in order to comply with employment legislation.
• Pension arrangements that guarantee pensions with limited or no abatement on termination or early retirement are no longer acceptable, unless generally available to all employees. Such conditions should not be included in new contracts of employment and existing guarantees should be amended where possible (without compensation).

The re-issue of the guidelines comes at a time when research published by the ABI purports to show that poor corporate governance reduces profits. The research shows that companies with the best corporate governance records have produced returns 18% higher than those with poor governance over a 4 year period. The ABI views adequate controls over executive remuneration as an indicator of general control over executive directors by non-executive directors, and as trading conditions are likely to become tougher, investor comment on executive director employment contracts and severance payments is unlikely to the leave the news.