High Court nullifies remuneration committee exercise discretion

20 October 2006

The High Court declares the exercise of a remuneration committee's discretion a nullity and orders it to reconsider while preventing its reliance on alleged wrongdoing where the company takes no action to seek available remedies.

McCarthy v McCarthy & Stone plc is the latest striking example in a series of cases on the invalid use of discretion in share plans by remuneration committee.

Brief Facts

Mr McCarthy had been a director and, latterly, an employee of McCarthy & Stone plc which is a listed company. He retired in what appear to have been acrimonious circumstances.

After he retired Mr McCarthy tried to exercise share options he had held for several years. Mr McCarthy's option was subject to a stretching EPS performance target measured over a 3 year performance period. The target had been met in full and he was entitled to exercise it in respect of 100% of his option shares before he left.

Under the option plan rules there was a period of 12 months during which it could be exercised in the absolute discretion of the remuneration committee (which was obliged to consider the extent to which the performance target had been satisfied at the date of the option holder's termination of employment in exercising that discretion). If the discretion was exercised in an option holder's favour then the option holder was entitled to exercise the option pro-rata to the achievement of the performance condition.

The rule was designed to apply to those option holders who ceased their employment during a performance period. However, the remuneration committee decided to interpret the rules as giving them an overarching discretion as to whether, and if so how many options, Mr McCarthy could exercise (even though the performance period had ended and he was entitled to exercise the option in full before he left).

The remuneration committee allowed Mr McCarthy to exercise only 75% of the options. It minuted various complaints against Mr McCarthy in relation to a share offer which it took into account in reaching its decision. However, the court noted that at no time did the company allege any breach of duty by, or commence proceedings against, Mr McCarthy.

The Decision

The High Court decided this was not a bona fide exercise of the remuneration committee's discretion, declared it a nullity and ordered the remuneration committee to re-consider.

It held that if an option holder had left during the performance period it would have been possible for the remuneration committee to consider whether or not to allow or deny the exercise of options if it relied upon reasons affecting the extent to which the performance target was satisfied as at the date of termination.

In Mr McCarthy's case, the conduct the remuneration committee complained of could not bona fide have been taken into account in deciding how to exercise its discretion, as:

  1. it had not affected the achievement of the target and so was irrelevant when it came to exercise of the discretion; and

  2. the company clearly had remedies for the alleged conduct but had not chosen to institute proceedings for a remedy against Mr McCarthy.

Potential for embarassment

The potential for embarrassment caused by a remuneration committee being the subject of a high court order nullifying its decision and ordering it to try again is striking.

So is the possibility that the remuneration committee which tries to rely on the wrongdoing of an employee or director to deny benefits, may find its decisions rendered void unless it has sought to enforce other remedies available against the individual.

Apparently, the remuneration committee in his case had taken legal advice. It underlines not only the importance of correctly interpreting and exercising discretions but also the importance of being careful who one takes advice from.

Trying to bend a rule to fit circumstances it was not designed for is a bad start to a situation in which one has to show good faith. One wonders what has happened to common sense as a currency.

There is no substitute for the proper consideration of drafting to take account of leavers both when drafting the rules in the first place and when relying on them.

Case Reference

The High Court judgment was issued on 20th July 2006, case reference: McCarthy v McCarthy & Stone plc [2006] EWHC 1851 (Ch).