Executive contracts and severance

07 April 2008

The Association of British Insurers and the National Association of Pension Funds updated their joint statement on executive contracts and severance on 18 February 2008. The statement, first published in 2002, assists companies with the design and application of contracts for when senior staff depart. It is also used by shareholders when assessing whether a situation exists where failure is being rewarded.

This joint statement can be found on the IVIS website: http://www.ivis.co.uk/ExecutiveContractsAndSeverance.aspx

Once again, payments to departing senior executives are under press scrutiny following the payment to Adam Applegarth, the departing Chief Executive of Northern Rock, so it is very important that Remuneration Committees take account of all the relevant rules and guidelines alongside the new joint statement, including:


The statement is intended to emphasise certain aspects of the Combined Code and provide guidance on shareholders’ expectations, rather than introducing any significant new obligations for companies. In particular, it makes the following points:

Contract policy and terms

· Key elements of director’s contracts should be disclosed on company website and summarised in the Remuneration Report (2.7).

· Contract policy including terminations and the approach to mitigation should be clearly explained in the Remuneration Report. Corporate objectives set for executives by the Board should be clear and, wherever possible, objectives against which performance will be measured should be made public (3.2).

· The policy and objectives on directors’ contracts should be clearly stated in the Remuneration Report (3.3).

· Remuneration Committees should review directors’ contracts periodically and consider whether they are appropriate if they would result in large payments in the case of failure to perform (3.4).

Notice periods

Encouragement is now given to boards to consider making directors’ contracts with a shorter notice period than the standard 12 months (3.5).

Severance payments

  • Severance payments arising from poor corporate performance should not extend beyond basic salary (2.6).

  • The constituent part of any severance payments should be fully disclosed in the Remuneration Report, together with the justification for the total level and elements paid (2.8).

  • No director should be entitled to discretionary payments if their contract is terminated for poor performance. Remuneration Committees should consider retaining their discretion to reclaim bonuses if performance achievements are subsequently found to have been significantly misstated (3.8).

  • Contracts should not provide additional compensation for severance as a result of change of control (3.9).

  • The full benefit of mitigation should be obtained, which includes the legal obligation of the outgoing senior executive to mitigate the loss incurred through severance by seeking other employment and reducing the need for compensation. Phased payments will generally be appropriate for fulfilling compensation on early termination. The ABI and NAPF are not supportive of the liquidated damages approach which involves agreement at the outset on the amount that will be paid on severance. (3.10).

Pensions

Remuneration Committees should identify, review and disclose in the Remuneration Report any arrangements that guarantee pensions with limited or no abatement on severance or early retirement. These arrangements are no longer regarded as acceptable, except where they are generally available to all employees. Where opportunities arise, existing contracts should be amended and such conditions should not be included in new contracts (3.11).

Inspection arrangements

Directors’ contracts and any side letters relating to severance terms and pension arrangements should be readily available for shareholder inspection (3.12).

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