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Penalty appeal kicked into touch - Nosworthy v Instinctif Partners Ltd

24 April 2019

A court has recently upheld the actions of an employer (IP) which enforced bad leaver provisions contained in its articles of association (Articles). Those provisions required a resigning employee (N) to transfer her shares for minimal consideration and forfeit her loan notes.

N, who had received the shares and loan notes as deferred consideration on a share sale, sought to argue (among other things) that IP had acted unfairly and unreasonably and that the bad leaver provisions were unconscionable and a penalty. All arguments raised were rejected by the Employment Appeal Tribunal.

It was clear from the drafting of the relevant provisions of the Articles that IP had every right to treat N as a bad leaver on the basis that she had voluntarily resigned. It was irrelevant that N would have been deemed a good leaver in this case had she been dismissed (other than summarily) for cause.

It was noted by the tribunal that there was no suggestion here that N was unable to seek legal advice (particularly given that she had confirmed in the share sale and purchase agreement under which she acquired the shares and loan notes that she had in fact done so - in the context of restrictive covenants).

N had tried to argue that the bad leaver provisions were in law a “penalty” and, as such, were unenforceable.

A penalty is a contractual provision, which imposes a detriment on the party in breach of a primary obligation, where that detriment cannot be justified by reference to any legitimate interest of the innocent party in the performance of the primary obligation. Thus a penalty has to operate on a breach of contract.

An investment agreement, to which N was a party, contained a covenant that she would not become a bad leaver (as defined in the Articles). Whilst it was acknowledged that N had breached the investment agreement, IP was not relying on this breach to enforce the bad leaver provisions; it was simply applying the standalone rules set out in its Articles. Therefore the issue of penalties was not relevant.

This case provides comfort that leaver provisions in a company’s articles of association should not, by themselves, fall foul of the penalties regime.

The EAT judgment in the case can be found here:

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