UK Employment and Labour Law -- Quarterly Executive Summary (October 2007)

October 17, 2007

Welcome to the third Quarterly Executive Summary of 2007, in which we highlight key developments in UK Employment and Labour Law over the past three months.

A headline summary of cases and developments is provided below. A more detailed explanation and analysis is available by clicking on the appropriate link. For further details concerning cases and developments discussed in this Quarterly Executive Summary or for assistance on any UK Employment or Labour law matter, please contact James Cox or Daniel Pollard in Gibson Dunn’s London office.

Headlines

New Legislation on Company Directors. Major changes to UK company law, including an extension of the duties owed by company directors, came into force on 1 October 2007 as part of the implementation of the Companies Act 2006. Changes includes codification of directors’ duties, new rules on long term service contracts, new disclosure requirements for all directors’ service contracts and a relaxation of the rules on payments for loss of office. It is recommended that all UK directors receive appropriate briefing and training on their new duties.

The Companies Act 2006 (the "Act") consolidates and amends the law relating to companies incorporated in the United Kingdom. The Act is coming into force in stages. Most of the rules relating to company directors are set out in Part 10 of the Act and came into force on 1 October 2007. In summary the most significant changes are as follows:

Codification of Directors’ Duties. The Act not only codifies existing directors’ duties but introduces a number of new considerations which directors must have regard to in discharging their duties. Provisions of the Act governing duties to act within a director’s powers, promote the success of the company and exercise independent judgment are now in force. Further duties to avoid conflicts of interest, not to accept benefits from third parties and to declare interests in proposed transactions or arrangements come into force on 1 October 2008. Controversially, the Act sets out a list of factors that directors should have regard to when determining what is in the best interest of the company — the so called "enlightened shareholder value" test. In addition, the Act arguably enhances the standard of care to be exercised by directors when discharging their duties. Some commentators have predicted that this could increase bureaucracy and (together with the new rules on derivative actions) increase the scope for litigation. For further details please see Gibson Dunn Update: Directors’ Duties under the Companies Act 2006.
Long Term Service Contracts. Service or consultancy contracts for a "guaranteed term" of more than 2 years will require shareholders’ consent (this period was previously 5 years). There is a new exception for directors who only serve as directors of a wholly owned subsidiary.
Service Contracts. Companies must keep copies of directors service contracts (or a note of their terms) which were entered into on or after 1 October 2007 at their registered office (or another authorized place) together with any variations until at least 12 months have elapsed from their termination. Copies must also be made available to shareholders free of charge. There are criminal sanctions for failures to comply. These requirements now apply to all companies (both private and public) and apply irrespective of the length of the service agreement. (Note that similar rules apply to any "qualifying third party indemnity" agreements entered into with a director.)
Payments for Loss of Office. The law has been clarified to allow payments to be made to directors without needing shareholder consent if they are made in good faith in discharge of a legal obligation or by way of compensation for claims arising on termination of employment.
Loans to Directors. The general prohibition on making loans to directors (subject to various exceptions) has been replaced with a general requirement to seek shareholder consent. A broader range of exceptions has also been introduced. A more onerous regime continues to applies to public companies and their subsidiaries.
Substantial Property Transactions. A number of changes to the rules on substantial property transactions have been made, including an increase in the de minimis threshold from £2,000 to £5,000.

It is recommended that directors are fully briefed and, where appropriate, receive training on their new duties — which are relevant to both private, public and listed UK companies. Please contact James A. Cox for further details.

Exercise of discretion under a share options plan. The Court of Appeal rules that when exercising its "absolute discretion" under the rules of a share option plan, a Board of directors may only take factors into account which are expressly contemplated by the rules of the plan. Accordingly, a Board acted unlawfully by taking the substantial wrongdoing by the employee into account when exercising its discretion under the rules of a share option plan.

McCarthy v McCarthy and Stone Plc illustrates the strict limits placed by the courts upon the exercise by employers of a contractual discretion, in this case, when exercising a discretion under the terms of a share option plan. Mr. McCarthy had been the managing director of McCarthy and Stone Plc ("M&S"). He was granted a number of share options which were exercisable after a period of three years provided that an objective "performance condition" had been satisfied. The option would lapse upon the termination of employment subject to a rule which provided that the "Remuneration Committee shall in its absolute discretion determine whether the Option will be exercisable having considered the extent to which the Performance Condition has been achieved at the date of termination". Following the satisfaction of the performance condition Mr. McCarthy left M&S. He then joined a competitor and it was alleged that he sought to entice away a number of M&S’s employees and made a number of public statements alleging that M&S’s shares were overvalued. Having regard to these factors the Board’s Remuneration Committee, perhaps understandably, refused to exercise its discretion to allow Mr. McCarthy to exercise his options. Instead they allowed him to exercise 75% of his options. The Court of Appeal had no sympathy with M&S who, the court noted, had failed to pursue other remedies against Mr. McCarthy. Notwithstanding that reference to an "absolute discretion" it held that the strict interpretation of the rule only allowed them to take into account factors that, in good faith, had an impact upon the satisfaction of the Performance Condition. Mr. McCarthy’s conduct was not a relevant factor and, having determined that the performance condition was fully satisfied, the Remuneration Committee had no discretion to allow a lesser amount than 100% to vest. A similar interpretation could be applied to the exercise of an absolute discretion by an employer to pay bonus under a bonus scheme. This case highlights the need for careful drafting when introducing contractual discretion into a share option or other incentive arrangement.

Liabilities on termination of Commercial Agency. Since the introduction of the Commercial Agents Regulations there has been considerable uncertainly on the quantification of the "compensation" payable to self employed commercial (i.e. sales/commission) agents upon the termination of their agency. The House of Lords hold that this will be the actual damage suffered rather than a notional amount of two year’s commission as favoured by the French courts.

Commercial Agents (Council Directive) Regulations 1993 (the "Regulations") introduced specific protection for commercial agents into English law — as required by a European Directive. A commercial agent is a self-employed intermediary (whether an individual or a company) that has continuing authority to negotiate the sale or purchase of goods in the EEA. Under the Regulations, a commercial agent has a statutory entitlement to be either "indemnified" or "compensated" following the termination of the agency relationship ("compensation" being the default position). In a rare case concerning the interpretation of the Regulations, the House of Lords in Lonsdale v Howard and Hallam Limited considered how compensation should be calculated on termination of a commercial agency in the UK. Although the concept of compensation in the Directive was derived from French law, the House of Lords held that it was not necessary to follow the practice of the courts in France of awarding two years’ gross commission (i.e. without any deduction for expenses, mitigation or accelerated receipt). The correct measure of compensation should be the actual value of the agency to a hypothetical purchaser as a going concern — even though there is no market for such agencies in England. In this case the business was in decline, the profit was modest and there was no evidence that anyone would purchase it. Future cases are, therefore, likely to be settled (or decided if they come to court) on the basis of expert evidence as to the value of the agency "business". Notwithstanding this decision, those who engage commercial agents are likely to continue to prefer to agree to pay an "indemnity" upon termination which unlike compensation, is capped at one year’s commission.

Legislative Changes. On 1 October 2007 National Minimum Wage rates increase, the Commission for Equality and Human Rights is born, the Racial and Religious Hatred Act 2006 comes into force and, as previously reported, annual holiday entitlements increase. For further details of recent changes to English Company Law, click here.

In addition to the implementation of the Companies Act 2006, the following legislative changes come into force:

The National Minimum Wage rates increase on 1 October 2007 in line with inflation. The rates increase from: £5.35 to £5.52 (for workers aged over 22), from £4.45 to £4.60 (for workers aged between 18-21 and those doing certain accredited training) and from £3.30 to £3.40 (for workers aged between 16-17).

The Equal Opportunities Commission, Commission for Racial Equality and Disability Rights Commission are replaced with the new Commission for Equality and Human Rights which will now exercise various enforcement powers in relation to sexual, age, race and religious discrimination.

The Racial and Religious Hatred Act 2006 creates a criminal offence of stirring up racial hatred. Whilst of general application harassment and/or discrimination in the workplace could now also give rise to criminal sanctions (for both individuals and bodies corporate) in severe cases.

Increase to annual holiday entitlements take effect on 1 October 2007. Please see Gibson Dunn’s July 2007 Quarterly Executive Summary.

Please click on the appropriate link above for more details.

Gibson, Dunn & Crutcher lawyers are available to assist in addressing any questions you may have regarding these issues. For further details concerning cases and developments discussed in this Quarterly Executive Summary or for assistance on any UK Employment or Labour law matter, please contact the Gibson Dunn attorney with whom you work, James A. Cox (+44 (0)20 7071 4250, [email protected]) or Daniel Pollard (+44 (0)20 7071 4257, [email protected]) in the firm’s London office, or any member of Gibson Dunn’s Labor and Employment Practice Group.

Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

UK Employment and Labour Law — Quarterly Executive Summary (October 2007)