March 2018: Tapestry Case Alert: UK: Important case on malus, clawback, discretion and the role of RemCo

This week a much anticipated UK High Court case, concerning malus adjustments to awards under a Lloyds Bank LTIP, concluded in favour of the ex-Lloyds executives bringing the claim.

The judge determined that the awards did, in fact, vest in full and could not be lawfully withheld, ordering Lloyds Bank to pay GBP1.35million in shares to Eric Daniels (former CEO) and GBP933,239 in shares to Truett Tate (former head of wholesale banking). Lloyds Bank have since confirmed that the company will not appeal this ruling.

Share plan implications

There are a number of important points which were considered in the case, which should be taken into account when drafting malus and clawback terms, implementing them and making decisions to operate them. The case addressed:

  • Whether plan rules and awards can be lawfully amended, after grant, to include malus provisions?
  • What evidence of discretion is required when malus provisions are used?
  • Who can/should make decisions under share plans? The remuneration committee, the board or both?

Summary of facts

  • Two former senior employees of Lloyds Bank plc were granted LTIP awards in April and May 2009.
  • The awards were subject to a number of conditions including the success of the HBOS merger. (The merger did go ahead but Lloyds had needed a significant government bailout).
  • In January 2012, RemCo agreed the awards should be made in full and vest at or around 2 March 2012.
  • In February 2012, the LTIP rules were amended by RemCo, to include a malus provision to adjust awards (including to nil) at the “Committee’s” discretion.
  • In March 2012, a board meeting was held during which the negative implications of delivering the shares following the HBOS merger were considered.
  • This board meeting was adjourned and a RemCo meeting convened – it was determined that the performance conditions had been fully satisfied and the awards should vest in full.
  • The board meeting was reconvened and the bank decided, in light of the legal and reputational risks, not to honour the awards to Daniels and Tate.
  • Proceedings against the bank began 5 years later, in August 2017.

Amending plan rules and awards

The Lloyds LTIP rules allowed the “Committee” to amend the “Plan” at any time in any way. However, the plan rules also indicated that any conditions attaching to an “Award” must be determined at grant. Numerous arguments were raised and the Judge concluded with several important points:

The plan rules and the award are separate in nature. The provision to allow for amending the rules was intended to alter the structure and administration of the plan, not to amend existing award terms. In any event, amending awards to the detriment of participants should not be done lightly. In this case, no consent from participants was sought in relation to the detrimental amendment. The amendment was also made after the performance conditions had been satisfied and the awards had likely already vested.

The plan rules in this case set out a “cards on table” approach, where awards were granted with clear conditions from the outset. The Judge determined that the malus terms were not “conditions” but, instead, a mechanism to exercise discretion after conditions are satisfied. However, inserting malus terms after the grant date was nevertheless entirely inconsistent with the “cards on table” approach of the plan.

Tapestry comment
If you are looking to amend your company’s plan rules and awards, this case is a clear reminder that you should not make adjustments to the detriment of existing participants, without careful consideration. The plan rules probably did not require any employee consent to make amendments to the plan but the judge took the view that, if it was to add a significant detrimental term, then their agreement would be required. This case is under English law but there will be similar legal principles in other countries. You should also consider the wording of your malus and clawback clauses and whether these are enforceable. Whilst it is, of course, possible to rely on malus and clawback terms, these must be properly incorporated into any agreement.

Discretion

Also considered was the discretion to exercise the malus provision. It was made clear that any decision to exercise discretion cannot be made arbitrarily, capriciously or irrationally. Such a decision should also be evidenced.

Without concluding whether the discretion was lawful, the Judge made it clear that evidence of considerations, when exercising discretion, should be well documented. In this case, the board minutes did not adequately consider whether the bank’s recent performance and the potential negative implications associated with the awards, justified the bank’s withholding of those awards.

Tapestry comment
We have previously reported on the importance of clear minute taking and ensuring decisions are well documented. This case is a further reminder of the importance of meeting minutes and how they may end up being used as evidence, or demonstrate a lack of evidence, in any proceedings.

Decisions by RemCo and the board

One of the key questions considered, was whether the board, in this case, were in fact able to make the decision to reduce the awards under the plan.

The Judge highlighted that under the plan rules “the Committee” had the discretion to adjust awards under the malus provisions. Turning to the definitions in the rules, “the Committee” was defined as “a duly authorised committee of the board of directors of the Company”. The Judge made it clear that, based on this wording, the Board were not in a position to determine the exercise of discretion in relation to malus provisions. The Board and the Committee are not one and the same and whilst both can have authority to exercise discretions, the plan rules must provide for this.

Tapestry comment
This point is of particular interest to the share plans industry where plan rules often overlap the role of the “Board” and the role of the “Committee”. What this case has shown is that the words of the plan rules will be carefully reviewed if there is litigation. Decisions to exercise malus provisions can be discussed at Board level but must be made by the body that has power under the plan rules, in this case, the RemCo. You should ensure clarity in your plan rules and that you are comfortable with which body or bodies have the authority to make key decisions. It is also important to keep under review what the plan rules and the terms of the malus and clawback say, and that they meet the practice in your company.

This is a significant decision that has far-reaching implications for amending plan rules, exercising discretions, the use of malus and the decision making process.

If you want to discuss any of the points above, or want help with any of your share plans, please do contact us.

Janet Cooper OBE, Bob Grayson and Tom Parker

Janet CooperBob GraysonTom Parker

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