Protecting the business when executives depart from the company

The importance of the Senior Executives team for any business cannot be underestimated. They are ultimately responsible for the culture, performance and success of the business. However, what happens when a senior executive leaves the business. Have you considered how this may impact the business? What are the matters that any responsible business should consider in circumstances where a senior executive leaves?

Following on from our last article in relation to how to motivate senior executives, in this week’s article, we look at the factors an employer should consider ensuring the business is protected when senior employees wish to resign, or the business chooses to remove them.

There are many issues that should be considered when a senior member of the organisation leaves. Unfortunately, many of these matters should be properly considered way before a decision is made to either terminate the relevant employee, or before the employee’s terms of resignation are accepted. In fact, I would go further and say that prudent employers should be holding regular catch-ups with the senior executive team, to ensure that if there is any apprehension someone may be considering leaving, that this is not news when it occurs, and if they are vital, that the reasons for the move are addressed and perhaps the departure avoided. In any event if this does not occur at least the following should be considered:

• How will the departure affect the operation of the business and what must be done to manage this;
• Why the person is leaving and whether the issues affect others in the business and especially in the Executive’s team;
• The level of knowledge shared across the team about the matters dealt with by the Executive and how this will be managed;
• The timing of the departure;
• The messaging regarding the departure and its effect on both the departing employee and the rest of the business;
• The legal requirement, which we discuss more fully below.

One of the most important protections for any business is an appropriate contract of employment. It should provide for appropriate notice periods, which is vital to ensure the business can properly plan and manage a departure, garden leave clauses, and otherwise clearly identifies the rights and obligations of both parties. In particular, in addition to the standard clauses, an employment contract for an executive should include the following:

Notice Period

Notice of termination clauses sets out the amount of notice the employee and the business must provide before the employment relationship may terminate.

It is crucial that the notice clause sets out the notice that both the employer and the employee must provide so that each party knows exactly what to expect from the other.

In circumstances where a contract does not include an express term setting out the notice period, the courts will imply a term of “reasonable notice”. Reasonable notice will be determined on a range of factors such as age, length of service, time it would likely take for the employee to obtain commensurate employment, qualifications and so on. Accordingly, it may be found that reasonable notice is substantially more than the business was prepared to provide. For senior executives who have been employed for considerable periods of time, reasonable notice could be as much as 12 months.

An appropriate notice period can also act as an effective restraint of trade, as it will prevent an employee from starting with a competitor during that period. It is for these reasons that notice periods for senior executives are often more than the standard one month. It is also important that the contract allows for the payment of notice in lieu of the employee working the notice. If this is not the case, but the employer actually wants the employee to leave immediately, without the relevant clause allowing this, there may be an argument that doing so is a breach of the contract.

Garden Leave

A garden leave clause allows the business to isolate the employee from their business while having them remain employed. During the garden leave period, the employee remains an employee of the business and as such, has the same obligations and duties to the business as any other employee, however the employee is not required to attend for work. In addition, other restrictions can be imposed including that they have no direct contact with clients, suppliers and/or access to confidential information.

Garden leave can therefore be a great way of restraining an employee. For example, if your business suspects an employee has resigned to join a competitor it is unlikely the business will want to make a payment in lieu of notice as that would simply bring their termination date forward, meaning the employee could start with the competitor even sooner. Placing the employee on garden leave, ensure they are unable to commence with the new employer or compete with the business for the notice period, but allows them nonetheless to be removed from the operation of the business.

Garden leave clauses also allow an employer to retain the knowledge of the employee for a transition period, but not necessarily have the employee attend for work. This may be invaluable in transitioning another person into the role or managing the departure.

It is important to understand that there is no general right to put an employee on garden leave and as such, a properly drafted clause should be included in the employment contract to allow the business to do so.

Restraints of Trade

Senior executives are usually the repository of the business’s knowledge and confidential information, not to mention customer connections and goodwill. When these employees leave, they create a substantial risk to the business. Well drafted post-employment contractual restraints can be an extremely useful tool to protect the business from the impact of former employees using this knowledge and connections for the benefit of others.

It is critical that a restraint of trade clause is carefully drafted to ensure that it is reasonable and enforceable. In this regard, the legal position is that post-employment restraints will be enforced if the employer seeking to enforce the restraint is able to show that the restraint is reasonable and necessary to protect the employer’s legitimate business interest.

Without appropriate restraint clauses, there is very little an ex-employer can do to prevent an employee from competing. The same observation can be made for the protection of confidential information. Unless the contract contains an appropriate clause dealing with the protection of confidentiality, the employer will need to rely on the common law which is very limited.

Termination Payments

It is not unusual in circumstances where the employment of executive employees occurs, to find that this creates significant disputation over the quantum of the termination payments, entitlement to bonuses, share options and other incentive payments. The contract of employment should make clear what payments will be made to an employee in these circumstances, and how discretionary benefits will be treated.

Lastly, in circumstances where a business may terminate an executive employee and is considering a termination payment, it is important to ensure the business does not breach its obligations under the Corporations Act 2000 (Cth). Specifically, the Corporations Act places limits on the quantum of termination benefits payable to relevant executives. For executives captured by these provisions, unless the business has obtained shareholder approval prior to the payment being made, the termination payment cannot be greater than the executive’s base remuneration in the preceding 12 months.

If you require assistance with drafting an executive employment contract, restraint provisions or require general employment law related advice, please feel free to contact our office.

This alert is not intended to constitute, and should not be treated as, legal advice.