When is senior executive is offered a ‘without prejudice’ severance package through a settlement agreement the primary focus of both parties is usually on the money. What is a reasonable (or sufficiently attractive) sum to pay to the executive in order to quickly resolve whatever destabilising situation has arisen?
Agreeing how the executive’s notice period is dealt with is an integral part of the financial negotiations which needs to be clearly set out in the settlement agreement. The senior executive will nearly always have a lengthy notice period: it will rarely be shorter than three months and periods of 6 months or even 12 months are not uncommon. Offering pay in lieu of notice (PILON) with an ex-gratia payment on top, which is tax free up to the first £30,000, is a very common approach.
Even in cases where the employer would be able to lawfully dismiss for gross misconduct, some employers will take a pragmatic approach and offer pay in lieu of notice as part of a settlement agreement. This is in exchange for employee agreeing not to bring any future claims against the employer and to avoid the management time and employment tribunal risks associated with disciplinary and dismissal procedures.
PILON is usually an attractive option to the executive because it means their employment can end without them having to work through their notice period. If they then receive income from a new employer in what would have been their notice period they will enjoy income from two salaries. (Unless, that is, there was a specific condition attached to the PILON clause in their employment contract requiring them to give credit for new income earned during their notice period).
PILON is often an attractive for option for the employer too. It means that the employment relationship can quickly be brought to an end avoiding the potentially destabilising effects of a disgruntled senior executive staying in the business. It also means that the executive will not accrue any further paid annual leave. This can be a considerable saving to the employer when the senior executive is on a salary of circa £100,000+. Each day of accrued but untaken annual leave amounts to a significant amount of money which will also need to be paid in lieu to the executive when their employment ends.
On the other hand, serving out the notice period on garden leave rather than using PILON might suit both parties better (assuming there is a garden leave clause in the employment contract). The executive might feel they are in a stronger position seeking new employment whilst still employed or they may wish to remain in employment up to a key date when share options (or other contractual bonuses) might become payable. Garden leave also offers advantages for the employer: it keeps the executive out of the marketplace whilst keeping them available to assist with handovers to their replacements.
But what happens when the parties disagree about how the executive’s notice period should be dealt with? The Court of Appeal has recently reconsidered the issue in the case of McKenzie v AA Ltd [2022] EWCA 901. The Court reaffirmed the long-established rule that the employer can choose the “least burdensome method” of terminating a contract when it has alternatives available to it.
The brief facts in the latest “least burdensome rule” case
Mr McKenzie was the Chief Executive of the AA. His employment contract stated that his employment could be ended in one of three ways:
- 12 months’ notice which could be given by either party;
- unilaterally by the company with pay in lieu of basic salary (i.e. without pay in lieu of contractual benefits including bonuses or share options);
- summary dismissal in the case of gross misconduct.
Mr McKenzie assaulted a junior colleague in a bar at the end of a strategy awayday. He immediately resigned and asked the AA for 12 months PILON. The AA refused and dismissed him for gross misconduct without notice. Mr McKenzie brought a wrongful dismissal claim in the High Court for payment of 12 months’ notice; damages for the loss of benefits, bonuses and shares he would have been entitled to if his employment had continued for a further 12 months; and damages for psychiatric injury.
A psychiatric report submitted to the High Court stated that Mr Mackenzie’s assault on the colleague was the result of excessive alcohol and extreme stress caused by pressure of work. It recommended that Mr Mackenzie take at least six months off work. Mr Mackenzie relied on the report to argue that the AA should place him on sick leave whilst he recovered and appoint an interim CEO in the meantime.
At a preliminary hearing, the High Court struck out Mr McKenzie's claim for benefits, bonuses and shares as having no reasonable prospect of success. It relied on the least burdensome rule that in assessing damages for an employee who claims to have been wrongfully dismissed a court or tribunal must assume that an employer would have terminated the contract as soon as it lawfully could. In Mr Mackenzie’s case that would mean pay in lieu of basic salary only. It was not reasonable to expect the AA to place Mr Mackenzie on sick leave and appoint an interim CEO.
Mr Mackenzie appealed the High Court’s decision to strike out his claim for benefits, bonuses and shares arguing that the least burdensome rule, established 150 years ago, should no longer apply.
Observations on the Court of Appeal’s decision on the least burdensome rule
In rejecting Mr Mackenzie’s appeal, the Court of Appeal reaffirmed that the least burdensome rule still applies. However the Court also observed that the least burdensome rule will not always mean the quickest or cheapest option lawful option available to the employer. Each case must be assessed on it facts. It will be interesting to see if this observation might assist either employers or employees when one party wants to apply the PILON whilst the party argues for either garden leave or to work thought the notice period.
If you are an employer or a senior executive and would like advice on either drafting a settlement agreement or on the terms of severance package offered to you, don’t hesitate to contact our employment team.